We always try to hit the jackpot while picking stocks. But striking the right chord each time is not easy unless blessed with Midas touch. When it comes to the investment market, experts consider value style as one of the most effective approaches. Value investing is essentially about selecting stocks that have good things going on for them, even at a time when they have been beaten down by some external factors.
There are different valuation metrics to determine a stock’s inherent strength but a random selection of ratios cannot serve your purpose if you want a realistic assessment of a company’s financial position. For this, we recommend Price to Cash Flow (or P/CF) as one of the key metrics. This metric evaluates the market price of a stock relative to the amount of cash flow that the company is generating on a per-share basis — the lower the number, the better. Unum Group UNM, General Motors Company GM, American International Group, Inc. AIG and Park Hotels & Resorts PK boast a low P/CF ratio.
Price to Cash Flow Reveals Financial Health
Questions may arise as to why we are considering the Price to Cash Flow valuation metric, when the most widely used metric is Price/Earnings (or P/E). Well, what makes P/CF stand out is that operating cash flow adds back non-cash charges such as depreciation and amortization to net income, truly reflecting the financial health of a company.
Analysts caution that a company’s earnings are subject to accounting estimates and management manipulation. However, cash flow is reliable. It is net cash flow that reveals how much money a company is actually generating and how effectively management is putting the same to use.
A positive cash flow indicates an increase in the company’s liquid assets. This gives the company the means to settle debt, shell out for its expenses, reinvest in its business, endure downturns and finally pay back its shareholders. Then again, a negative cash flow implies a decline in the company’s liquidity, which in turn lowers its flexibility to support these moves.
What’s the Best Strategy?
An investment decision solely based on the P/CF metric may not fetch the desired results. To identify stocks that are trading at a discount, you should expand your search criteria and also consider the price-to-book ratio, price-to-earnings ratio and price-to-sales ratio. Adding a favorable Zacks Rank and a Value Score of A or B to your search criteria should lead to even better results as these eliminate the chance of falling into a value trap.
Here are the parameters for selecting true value stocks:
P/CF less than or equal to X-Industry Median.
Price greater than or equal to 5: The stocks must all be trading at a minimum of $5 or higher.
Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that the stock is easily tradable.
P/E using (F1) less than or equal to X-Industry Median: This parameter shortlists stocks that are trading at a discount or are equal to their peers.
P/B less than or equal to X-Industry Median: A lower P/B compared with the industry average implies that there is enough room for the stock to gain.
P/S less than or equal to X-Industry Median: The P/S ratio determines how a stock price compares to the company’s sales — the lower the ratio the more attractive the stock is.
PEG less than 1: The ratio is used to determine a stock's value by taking the company's earnings growth into account. The PEG ratio portrays a more complete picture than the P/E ratio. A value of less than 1 indicates that the stock is undervalued and that investors need to pay less for a stock that has robust earnings growth prospects.
Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.
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 four of the nine stocks that qualified the screening:
Unum Group, which provides financial protection benefit solutions, sports a Zacks Rank #1 and has an expected EPS growth rate of 9.1% for three-five years. The company has a trailing four-quarter earnings surprise of 18.6%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for Unum Group’s current financial year sales and EPS suggests growth of 2.3% and 17.6%, respectively, from the year-ago period. Unum Group has a Value Score of A. Shares of UNM have gained 33.6% in the past year.
General Motors, which designs, builds, and sells cars, trucks, crossovers, and automobile parts globally, flaunts a Zacks Rank #1. It has an expected EPS growth rate of 9.9% for three-five years. The company has a trailing four-quarter earnings surprise of 15.5%, on average.
The Zacks Consensus Estimate for General Motors’ current financial year sales suggests growth of 4.5% from the year-ago period. General Motors has a Value Score of A. Shares of GM have declined 6.7% in the past year.
American International Group, which offers insurance products for commercial, institutional, and individual customers, carries a Zacks Rank #1 and has an expected EPS growth rate of 10% for three-five years. The company has a trailing four-quarter earnings surprise of 9.2%, on average.
The Zacks Consensus Estimate for American International Group’s current financial year sales and EPS suggests growth of 6.6% and 42.2%, respectively, from the year-ago period. AIG has a Value Score of A. Shares of AIG have tumbled 4.6% in the past year.
Park Hotels & Resorts, one of the largest publicly-traded lodging REITs with a diverse portfolio of iconic and market-leading hotels and resorts, carries a Zacks Rank #2. PK has a Value Score of A and an expected EPS growth rate of 9.6% for three-five years.
Park Hotels & Resorts has a trailing four-quarter earnings surprise of 15.7%, on average. The Zacks Consensus Estimate for current financial year sales and EPS suggests growth of 9% and 30.5%, respectively, from the year-ago period. Shares of PK have fallen 18.2% in the past year.
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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: https://www.zacks.com/performance.
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