The price-to-earnings (P/E) multiple enjoys wide-scale popularity among investors seeking stocks trading at a bargain. In addition to being a widely-used tool for screening stocks, P/E is a popular metric to work out the fair market value of a firm. But even this ubiquitously used valuation multiple has a few downsides.
Although P/E is the most popular valuation metric, a more complicated multiple called EV-to-EBITDA works even better. Often considered a better alternative to P/E, it gives the true picture of a company’s valuation and earning potential, and has a more complete approach to valuation. While P/E considers a firm’s equity portion, EV-to-EBITDA determines its total value.
Greif, Inc. GEF, G-III Apparel Group, Ltd. GIII, USA Truck, Inc. USAK, SpartanNash Company SPTN and AdvanSix Inc. ASIX are some stocks with impressive EV-to-EBITDA ratios.
Is EV-to-EBITDA a Better Substitute to P/E?
EV-to-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.
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.
Typically, 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. For 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.
Another shortcoming of P/E is that it can’t be used to value a loss-making firm. A company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV-to-EBITDA is difficult to manipulate and can also be used to value companies making losses but are EBITDA-positive.
EV-to-EBITDA is also a useful tool in evaluating 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 bargain 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 our five picks out of the 16 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 36.8% for the current fiscal year. The Zacks Consensus Estimate for GEF's current fiscal-year earnings has been revised 17.8% upward over the past 60 days.
G-III Apparel is a manufacturer, designer and distributor of apparel and accessories under licensed brands, owned brands and private label brands. 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.
G-III Apparel has an expected earnings growth rate of 10.4% for the current fiscal year. The Zacks Consensus Estimate for GIII’s current-year earnings has been revised 4.7% upward over the past 60 days.
USA Truck is engaged in the transportation of general commodity freight in interstate and foreign commerce. This Zacks Rank #1 stock has a Value Score of B.
USA Truck has an expected earnings growth rate of 59.1% for the current year. The Zacks Consensus Estimate for USAK’s current-year earnings has been revised 15.8% upward over the past 60 days.
SpartanNash distributes grocery products to a diverse group of independent and chain retailers, its corporate-owned retail stores, and U.S. military commissaries and exchanges. This Zacks Rank #2 stock has a Value Score of A.
SpartanNash has an expected earnings growth rate of 35.3% for the current year. The Zacks Consensus Estimate for SPTN's current-year earnings has been revised 11.7% upward over the past 60 days.
AdvanSix is a manufacturer of nylon 6 resin, chemical intermediates and ammonium sulfate fertilizer. This Zacks Rank #2 stock has a Value Score of A.
AdvanSix has an expected earnings growth rate of 66.1% for the current year. ASIX has outpaced the Zacks Consensus Estimate in three of the trailing four quarters. In this time frame, it has delivered an earnings surprise of 20.5%, on average.
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GIII Apparel Group, LTD. (GIII) : Free Stock Analysis Report
Greif, Inc. (GEF) : Free Stock Analysis Report
SpartanNash Company (SPTN) : Free Stock Analysis Report
USA Truck, Inc. (USAK) : Free Stock Analysis Report
AdvanSix (ASIX) : Free Stock Analysis Report
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