Stocks with low P/E are always investors’ favorites as the ratio indicates undervaluation. This ratio is obtained by dividing a stock’s current market price with its historical or estimated earnings. It measures how much an investor needs to shell out per dollar of earnings.
So the golden rule is – the lower the P/E of a stock, the higher its value for investors. This is because value investors believe that a stock's current market price is not reflective of its historical/future earnings and therefore chances of outperformance are higher.
Naturally, there are very few investors who pay attention to stocks with an increasing P/E. But this often overlooked trend can prove worthwhile in finding great stocks. Let’s dig a little deeper.
How Can Rising P/E Be Helpful?
Investors should note that stock prices move in tandem with earnings performance. If earnings come in stronger, the price of a stock soars. Solid quarterly earnings and guidance in turn boost the earnings forecast, leading to stronger demand for the stock and an uptrend in its price.
So, if the price is rising steadily, it means that investors are assured of the stock’s fundamental strength, expect some strong positives out of it as well as solid and faster earnings growth. Moreover, studies have revealed that stocks have seen their P/E ratios jump over 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth.
Percentage change in last year EPS should be greater than or equal to the previous year.
(These two criteria point to flat earnings or a growth trend over the years)
Percentage change in price over four weeks greater than the percentage change in price over 12 weeks.
Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks.
(These two criteria show that the price of the stock is increasing consistently over the said timeframes)
Percentage price change for four weeks relative to the S&P 500 greater than the percentage price change for 12 weeks relative to the S&P 500.
Percentage price change for 12 weeks relative to the S&P 500 greater than the percentage price change for 24 weeks relative to the S&P 500.
(Here, the case for consistent price gains gets even stronger as it displays percentage price changes relative to the S&P 500)
Percentage price change for 12 weeks is 20% higher than or equal to the percentage price change for 24 weeks, but it should not exceed 100%.
(A 20% increase in the price of a stock from the breakout point gives cues of an impending uptrend. But a jump of over 100% indicates that there is limited scope for further upside and that the stock might be due for a reversal)
In addition, we place a few other criteria that lead us to some likely outperformers.
Zacks Rank less than or equal to 2: Only companies with a Strong Buy or Buy rating can get through.
Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.
Just these few criteria narrowed down the universe from over 7,700 stocks to just 5.
Here are the five stocks:
VeriSign Inc. VRSN: The company is into domain names and Internet security with the Zacks Industry Rank in the top 25%. The stock has a Zacks Rank #2 (Buy).
Motorcar Parts of America Inc. MPAA: It is a renowned manufacturer of replacement alternators and starters for imported and domestic cars and light trucks. The Zacks Industry Rank of the stock is in the top 2%. The stock has a Zacks Rank #1 (Strong Buy). You can see the complete list of today’s Zacks #1 Rank stocks here.
EnteroMedics Inc. ETRM: This Zacks Rank #2 company develops and commercializes a new therapeutic platform for treating various acute and chronic diseases. The Zacks Industry Rank of the stock is in the top 39%.
Uranium Resources Inc. URRE: The Zacks Rank #2 company is into the acquisition, exploration and development of properties for the mining of uranium. The Zacks Industry Rank of the stock is in the top 18%.
Leidos Holdings Inc. LDOS: This is a provider of science and technology solutions. The Zacks Industry Rank of the stock is in the top 29% and the stock has a Zacks Rank #2.
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Disclosure: Officers, directors and/or employees of Zacks Investment Research may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material. An affiliated investment advisory firm may own or have sold short securities and/or hold long and/or short positions in options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: http://www.zacks.com/performance
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