5 Stocks With Strikingly Low EV/EBITDA Ratios To Buy Now

Price-to-earnings (P/E) is by far the most popular metric used by investors to work out the fair value of a stock. Many prefer to take the P/E route in their pursuit of a portfolio of stocks with attractive prices. In fact, the idea of chasing stocks with a low P/E is ingrained in the minds of many value investors. However, even this easy-to-compute, widely used metric is not without its pitfalls.

EV/EBITDA is a Better Approach, Here’s Why

No doubt P/E enjoys great popularity among value inventors. But a more complicated and less used metric called EV/EBITDA is sometimes viewed as a better alternative as it offers a clearer picture of a firm’s valuation and its earnings potential.

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 entire value of a company.

EBITDA, the other component of the ratio, gives the true picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that depress net earnings. It is also often used as a proxy for cash flows.

Usually, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could imply that a stock is potentially undervalued and vice versa.

Also referred to as the enterprise multiple, EV/EBITDA takes a more complete approach to valuation. It takes into account the debt on a company’s balance sheet that P/E ratio ignores. This is the reason why EV/EBITDA is typically used to value potential acquisition targets. It shows the amount of debt the acquirer has to bear. Stocks boasting a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another flaw of P/E is that it can’t be used to value a loss-making firm. Moreover, a company’s earnings are subject to accounting estimates and management manipulation. On the contrary, EV/EBITDA is less susceptible to manipulation and can also be used to value firms that have negative net earnings but are positive at the EBITDA level.

EV/EBITDA also determines the total value of a company while P/E solely considers its equity portion. EV/EBITDA is also a useful tool in measuring the value of companies with highly leveraged balance sheets and substantial depreciation and amortization expenses. It also can be used to compare companies with different levels of debt.

However, EV/EBITDA is too not devoid of drawbacks. The ratio varies across industries (a high-growth industry typically has higher multiple) and is usually not appropriate for comparing stocks in different industries due to their diverse capital expenditure requirements.

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So, instead of solely banking on EV/EBITDA, you can combine 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.

Screening Criteria

Here are the parameters to screen for value 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.

Original post

Written By: Zacks Investment Research