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Tap 5 Bargain Stocks with Amazingly Low EV/EBITDA Ratios

Zacks

The price-to-earnings (P/E) ratio is widely considered by value investors as a useful yardstick for working out the fair market value of a stock. Many prefer to take the P/E route in their pursuit of a portfolio of stocks with bargain prices. However, even this broadly used valuation multiple is not without its shortcomings.

Is EV/EBITDA a Better Substitute?

While the widespread use of P/E stems from its simplicity, a more complicated metric called EV/EBITDA is often viewed as a better approach as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA determines the total value of a firm while P/E just considers its equity portion.

Also referred to as the enterprise multiple, EV/EBITDA is the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). EV is the sum of a company’s market capitalization, its debt and preferred stock minus cash and cash equivalents. In essence, it is the total value of a firm.

The other component, EBITDA, gives a better understanding of a company’s profitability as it strips out the impact of non-cash expenses like depreciation and amortization that reduce net earnings.

Just like P/E, the lower the EV/EBITDA ratio, the more alluring it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued.

EV/EBITDA also takes into account the debt on a company’s balance sheet that P/E does not. This is why EV/EBITDA is typically used to value possible acquisition targets, as it shows the amount of debt the acquirer has to assume. Stocks sporting low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another major drawback of P/E is that it can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV/EBITDA is less amenable to manipulation and can also be used to value firms that have negative net earnings but are positive on the EBITDA front.

EV/EBITDA is also a useful tool in assessing the value of firms that are highly leveraged and have a high degree of depreciation. It also can be used to compare companies with different levels of debt.

However, EV/EBITDA is not devoid of limitations. The ratio alone can’t conclusively determine a stock’s inherent potential and its future performance. It varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.

As such, instead of solely relying on EV/EBITDA, you can combine it with the other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain stocks.

Screening Criteria

Here are the parameters to screen for bargain stocks:

EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/EBITDA ratio represents a cheaper valuation.

P/E using (F1) less than X-Industry Median: This metric screens stocks that are trading at a discount to their peers.

P/B less than X-Industry Median: A lower P/B compared with the industry average implies that the stock is undervalued.

P/S less than X-Industry Median: The lower the P/S ratio the more attractive the stock is as investors will have to pay a smaller price for the same amount of sales generated by the company.

Estimated One-Year EPS Growth F(1)/F(0) greater than or equal to X-Industry Median: This parameter will help in screening stocks that have growth rates higher than the industry median. This is a meaningful indicator as decent earnings growth always adds to investor optimism.

Average 20-day Volume greater than or equal to 100,000: The addition of this metric ensures that shares can be traded easily.

Current Price greater than or equal to $5: This parameter will help in screening stocks that are trading at a minimum price of $5 or higher.

Zacks Rank less than or equal to 2: No screening is complete without the Zacks Rank, which has proven its worth since inception. It is a fundamental truth that stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) have always managed to beat adversities and outperform the market.

Value Score of less than or equal to B: Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are five of the 13 stocks that passed the screen:

Big 5 Sporting Goods Corporation BGFV is a leading sporting goods retailer in the western U.S., operating stores under the name Big 5 Sporting Goods. This Zacks Rank #1 stock has an expected earnings per share (EPS) growth rate of 12% for 3 to 5 years.

Kelly Services, Inc. KELYA offers temporary office clerical, marketing, professional, technical, light industrial, home care services, management services and other business services to a diversified group of customers. This Zacks Rank #1 stock delivered an average positive earnings surprise of around 17.1% in the trailing four quarters. You can see the complete list of today’s Zacks #1 Rank stocks here.

SORL Auto Parts, Inc. SORL specializes in the development, production and distribution of air brake valves and hydraulic brake valves. This Zacks Rank #1 stock delivered an average positive earnings surprise of 94.5% in the trailing four quarters.

American Equity Investment Life Holding Company AEL is a full-service underwriter of a broad line of annuity and insurance products, with primary emphasis on the sale of fixed rate and index annuities. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 71.2% for 2017.

Prudential Financial, Inc. PRU is one of the largest financial services institutions in the U.S., offering a wide range of insurance, investment management and other financial products and services. This Zacks Rank #2 stock has an expected EPS growth rate of 8.5% for 3 to 5 years.

You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard today.

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: https://www.zacks.com/performance.


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