5 Bargain Stocks With Strikingly Low EV/EBITDA Ratios

Investors typically have a fixation for the price-to-earnings (P/E) strategy in their quest for stocks that are trading at bargain prices. Without doubt, P/E is the most popular metric for working out the fair market value of a stock. However, even this widely used valuation multiple is not devoid of shortcomings.

What Makes EV/EBITDA a Better Alternative?

The popularity of P/E stems from its simplicity. However, a more complicated and less used metric called EV/EBITDA is often viewed as a better alternative as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA has a more complete approach to valuation as it determines a firm’s total value. In contrast, P/E just considers a firm’s equity portion.

Also referred to as the enterprise multiple, 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. Essentially, it is the full value of a company.

The other constituent, EBITDA, gives a better understanding of a company’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that dilute net earnings. It is also often used as a proxy for cash flows.

Just like P/E, the lower the EV/EBITDA ratio, the more attractive it is. A low EV/EBITDA ratio could signal that a stock is potentially undervalued.

EV/EBITDA takes debt on a company’s balance sheet into account that P/E does not. Due to this reason, EV/EBITDA is typically used to value possible acquisition targets, as it shows the amount of debt the acquirer has to assume. Companies with a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another key drawback 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. In comparison, EV/EBITDA is less amenable to manipulation and can also be used to value firms that have negative net earnings but are positive on the EBITDA front.

EV/EBITDA is also a useful tool in measuring the value of companies that are highly leveraged and have a high degree of depreciation. Moreover, the ratio allows the comparison of companies with different debt levels.

However, EV/EBITDA is also not without its downsides and alone can’t conclusively determine a stock’s inherent potential and future performance. The multiple varies across industries (a high-growth industry generally has higher multiple) and is usually not appropriate while comparing stocks in different industries given their diverse capital requirements.

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Thus, instead of solely relying on EV/EBITDA, you can combine it with the other key ratios such as price-to-book (P/B), P/E and price-to-sales (P/S) to achieve the desired outcome.

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.

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