Investors love stocks with a low price-to-earnings (P/E) ratio. The perception is that the lower the P/E, the higher will be the value of the stock. The simple logic that a stock’s current market price does not justify (is not equivalent to) its higher earnings and therefore has room to run is behind investors’ inclination toward low P/E stocks.
But stocks with a rising P/E can also be worth buying. We’ll tell you why.
Why Rising P/E a Valuable Tool?
Investors should note that stock price moves in tandem with earnings performance. If earnings come in stronger, the price of a stock shoots up. Solid quarterly earnings and the forward guidance boost earnings forecasts, 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 and expect some strong positives out of it. Also, 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 zero
(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 price of the stock is increasing consistently over the said time frames.)
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 equals to 2: Only companies with a Zacks Rank #1 (Strong Buy) and a Zacks Rank #2 (Buy) 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 48.
Here are five out of 48:
Pilgrim's Pride Corporation PPC: This chicken company belongs to a top-rankedZacks industry (top 24%). The stock has a Zacks Rank #2.
NutriSystem Inc NTRI: It is a leader in the weight loss industry, having helped millions of people lose weight. The stock belongs to a top-ranked Zacks industry (top 26%) and has a Zacks Rank #2.
Wabco Holdings Inc. WBC: This Zacks Rank #2 company is one of the world's leading providers of electronic braking, stability, suspension and transmission control systems for heavy-duty commercial vehicle. The stock hails from a top-ranked Zacks industry (top 36%).
Matthews International Corporation MATW: The Zacks Rank #2 company is a manufacturer and marketer principally of memorialization products & brand solutions. The company hails from a top-ranked Zacks industry (top 41%).
Meritor Inc. MTOR: The company supplies drivetrain, mobility, braking and aftermarket solutions for commercial vehicle and industrial markets. It belongs to a top-ranked Zacks industry (top 36%)and 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: https://www.zacks.com/performance.
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Meritor, Inc. (MTOR) : Free Stock Analysis Report
Wabco Holdings Inc. (WBC) : Free Stock Analysis Report
Pilgrim's Pride Corporation (PPC) : Free Stock Analysis Report
Matthews International Corporation (MATW) : Free Stock Analysis Report
NutriSystem Inc (NTRI) : Free Stock Analysis Report
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