Price-to-earnings (P/E), given its apparent simplicity, is the most commonly used metric in the value-investing world. The ratio enjoys greater popularity among valuation metrics in the investment toolkit and is preferred while uncovering stocks trading at attractive prices. But even this universally used valuation multiple is not without its limitations.
While P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV-to-EBITDA is sometimes viewed as a better alternative. EV-to-EBITDA gives the true picture of a company’s valuation and earnings potential. It has a more comprehensive approach to valuation.
Greif, Inc. GEF, Berry Global Group, Inc. BERY, DXC Technology Company DXC, The Container Store Group, Inc. TCS and Hillenbrand, Inc. HI are some stocks with attractive EV-to-EBITDA ratios.
What Makes EV-to-EBITDA a Better Option?
EV-to-EBITDA is essentially 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.
The other component of the multiple, EBITDA, gives a better idea of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.
Generally, the lower the EV-to-EBITDA ratio, the more attractive it is. A low EV-to-EBITDA ratio could signal that a stock is potentially undervalued.
Unlike the P/E ratio, EV-to-EBITDA takes debt on a company’s balance sheet into account. Due to this reason, it is typically used to value potential acquisition targets. The ratio shows the amount of debt that the acquirer has to bear. Stocks flaunting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates.
Moreover, P/E can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV-to-EBITDA is harder to manipulate and can be used to value companies that have negative net earnings but are positive on the EBITDA front.
EV-to-EBITDA is also a useful yardstick for measuring the value of firms that are highly leveraged and have a high degree of depreciation. Moreover, it can be used to compare companies with different levels of debt.
But EV-to-EBITDA has its limitations too. The ratio varies across industries (a high-growth industry typically has a higher multiple and vice versa) and is usually not appropriate while comparing stocks in different industries, given their diverse capital requirements.
Therefore, instead of solely relying on EV-to-EBITDA, you can club it with the other major ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to achieve the desired outcome.
Here are the parameters to screen for value stocks:
EV-to-EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV-to-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 Value Score of A or B when combined with a Zacks Rank #1 or 2 offer the best upside potential.
Here are five of the 18 stocks that passed the screen:
Greif is a leading global producer of industrial packaging products and services. This Zacks Rank #1 stock has a Value Score of A.
Greif has an expected year-over-year earnings growth rate of 11.4% for the current fiscal year. The Zacks Consensus Estimate for GEF's current fiscal year earnings has been revised 5.6% upward over the past 60 days.
Berry Global Group manufactures and distributes non-woven specialty materials, engineered materials and consumer packaging products in the market. This Zacks Rank #1 stock has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
Berry Global Group has an expected year-over-year earnings growth rate of 2.8% for the current fiscal year. The Zacks Consensus Estimate for BERY's current fiscal year earnings has been revised 18% upward over the past 60 days.
DXC Technology offers a broad array of professional services to clients in the global, commercial and government markets. DXC, a Zacks Rank #2 stock, has a Value Score of A.
DXC Technology has an expected year-over-year earnings growth rate of 51.4% for the current fiscal year. The Zacks Consensus Estimate for DXC's current fiscal year earnings has been revised 1.7% upward over the past 60 days.
The Container Store Group is a leading specialty retailer of storage and organization products and solutions, and custom closets. This Zacks Rank #2 stock has a Value Score of A.
The Container Store Group has an expected year-over-year earnings growth rate of 25% for the current fiscal year. TCS beat the Zacks Consensus Estimate for earnings in each of the trailing four quarters, the average being 101.5%.
Hillenbrand is a global diversified industrial company with businesses that serve a wide variety of industries across the globe. This Zacks Rank #2 stock has a Value Score of A.
Hillenbrand has an expected year-over-year earnings growth rate of 0.5% for the current fiscal year. The Zacks Consensus Estimate for HI's current fiscal year earnings has been revised 3.8% upward over the past 60 days.
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.
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Container Store The (TCS) : Free Stock Analysis Report
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