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Pick These 5 Bargain Stocks With Enticing EV/EBITDA Ratios

Anindya Barman
Earnings yield is handy for comparing the performance of the market with the 10-year Treasury yield.

The price-to-earnings (P/E) ratio is widely considered by investors as a yardstick for evaluating the fair market value of a stock. It is preferred by many investors to handpick stocks trading at attractive prices. However, even this universally used valuation multiple is not without its limitations.

Is EV/EBITDA a Better Alternative to P/E?

While P/E is hands down the most popular equity valuation ratio, there is another metric called EV/EBITDA that works even better in finding value stocks. This ratio is often viewed as a better substitute to P/E as it offers a clearer picture of a company’s valuation and earning potential. EV/EBITDA, also referred to as enterprise multiple, determines the total value of a firm while P/E considers just its equity portion.

EV/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. Simply put, it is the total value of a firm.

The other component, EBITDA gives the true picture of a firm’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that dilute net earnings.

Typically, the lower the EV/EBITDA ratio, the more attractive it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued and vice versa.

However, unlike P/E ratio, EV/EBITDA takes into account the debt on a company’s balance sheet. For this reason, EV/EBITDA is usually used to value possible acquisition targets. Stocks with a low EV/EBITDA multiple could be seen as potential takeover candidates.

Another downside of P/E is that it can’t be used to value a loss-making company. A company’s earnings are also subject to accounting estimates and management manipulation. EV/EBITDA, in contrast, is less amenable to manipulation and also can be used to value firms that have negative net earnings but are positive on the EBITDA side.

Moreover, EV/EBITDA allows the comparison of companies with different debt levels and is a useful tool in measuring the value of firms that are highly leveraged and have substantial depreciation and amortization expenses.

However, EV/EBITDA is also not without its shortcomings and alone cannot conclusively determine a stock’s inherent potential and future performance. The ratio varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.

As such, a strategy solely based on EV/EBITDA might not yield the desired results.  But you can club it with the other major ratios in your stock investing toolbox such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen bargain stocks.
 
Screening Criteria

Here are the parameters to screen for bargain stocks:

EV/EBITDA 12 Months-Most Recent less than X-Industry Median: A lower EV/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 12 stocks that passed the screen:

G-III Apparel Group, Ltd. GIII is a leading manufacturer and distributor of apparel and accessories under licensed brands, owned brands and private label brands. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 15.4% for the current fiscal year and a Value Score of A.

Vitamin Shoppe, Inc. VSI is a specialty retailer and direct marketer of nutritional products. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 92.3% for the current year. It also has a Value Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.

Tech Data Corporation TECD is one of the world's largest technology distributors. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 3.4% for the current fiscal year and a Value Score of A.

Israel Chemicals Ltd. ICL is a manufacturer of specialty fertilizers and specialty phosphates, flame retardants and water treatment solutions. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 10.8% for the current year. It also has a Value Score of A.

Smart & Final Stores, Inc. SFS is a value-oriented food and everyday staples retailer that serves household and business customers. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 4.8% for the current year and a Value Score of A.

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.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

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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.