Rising rate concerns cast a pall on Wall Street, bolstering the need for value investing. After all, 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 24.
Here are five out of the 24:
Organovo Holdings Inc. ONVO: This three-dimensional biology company belongs to a top-rankedZacks industry (top 43%). The stock has a Zacks Rank #2.
Westport Fuel Systems Inc. WPRT: It is engaged in engineering, manufacturing and supply of alternative fuel systems and components. The stock belongs to a top-ranked Zacks industry (top 31%) and has a Zacks Rank #2.
Koppers Holdings Inc. KOP: This Zacks Rank #2 company is an integrated global provider of treated wood products, wood treatment chemicals and carbon compounds. The stock comes from a top-ranked Zacks industry (top 8%).
Crown Holdings Inc. CCK: The Zacks Rank #1 company is a leading supplier of packaging products to consumer marketing companies around the world. The company hails from a top-ranked Zacks industry (top 20%).
Universal Forest Products Inc. UFPI: This is a holding company of businesses that combine to create one of the largest producers of wood and wood-alternative products in North America. It belongs to a top-ranked Zacks industry (top 6%). 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: https://www.zacks.com/performance.
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Universal Forest Products, Inc. (UFPI) : Free Stock Analysis Report
Koppers Holdings Inc. (KOP) : Free Stock Analysis Report
Crown Holdings, Inc. (CCK) : Free Stock Analysis Report
Westport Fuel Systems Inc. (WPRT) : Free Stock Analysis Report
Organovo Holdings, Inc. (ONVO) : Free Stock Analysis Report
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