Price-to-earnings (P/E), given its inherent simplicity, is the most commonly used metric in the value investing world. It is preferred by many investors while handpicking stocks trading at attractive prices. However, even this straightforward, broadly used valuation metric has a few limitations.
While P/E enjoys great popularity among value investors, a less-used and more-complicated metric called EV-to-EBITDA is sometimes viewed as a better alternative. EV-to-EBITDA gives the true picture of a company’s valuation and earnings potential. It has a more comprehensive approach to valuation.
PBF Energy Inc. PBF, Innoviva, Inc. INVA, Global Partners LP GLP, Heritage-Crystal Clean, Inc HCCI and Sterling Infrastructure, Inc. STRL are some stocks with impressive EV-to-EBITDA ratios.
What Makes EV-to-EBITDA a Better Alternative?
EV-to-EBITDA is essentially 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.
EBITDA, the other constituent of the ratio, gives a clearer picture of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that dampen net earnings. It is also often used as a proxy for cash flows.
Usually, the lower the EV-to-EBITDA ratio, the more appealing it is. A low EV-to-EBITDA ratio could be a sign that a stock is potentially undervalued.
However, unlike the P/E ratio, EV-to-EBITDA takes into account the debt on a company’s balance sheet. Given this reason, EV-to-EBITDA is usually used to value the possible acquisition targets. Stocks with a low EV-to-EBITDA multiple could be seen as potential takeover candidates.
P/E also can’t be used to value a loss-making firm. A firm’s earnings are also subject to accounting estimates and management manipulation. In contrast, EV-to-EBITDA is harder to manipulate and can be used to value companies with negative net earnings but are positive on the EBITDA front.
EV-to-EBITDA is also a useful yardstick 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.
However, EV-to-EBITDA is not devoid of shortcomings and alone can’t conclusively determine a stock’s inherent potential and future performance. The multiple varies across industries and is usually not appropriate while comparing stocks in different industries given their diverse capital expenditure requirements.
Therefore, a strategy solely based on EV-to-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 value stocks.
Here are the parameters to screen for value 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 12 stocks that passed the screen:
PBF Energy provides end products that comprise heating oil, transportation fuels, lubricants and many related products. This Zacks Rank #1 stock has a Value Score of A.
PBF Energy has an expected earnings growth rate of 1,048.8% for the current year. The Zacks Consensus Estimate for PBF’s current-year earnings has been revised 24.8% upward over the past 60 days.
Innoviva is a diversified holding company with a portfolio of royalties and other healthcare assets. INVA, flaunting a Zacks Rank #1, has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
Innoviva has an expected year-over-year earnings growth rate of 5.8% for the current year. The consensus estimate for INVA’s current-year earnings has been revised 8.8% upward over the last 60 days.
Global Partners is focused on the distribution of gasoline, distillates, residual oil and renewable fuels, apart from owning several refined-petroleum-product terminals. GLP, a Zacks Rank #1 stock, has a Value Score of A.
Global Partners has an expected year-over-year earnings growth rate of 654.2% for the current year. GLP’s consensus estimate for the current year has been revised 37.8% upward over the last 60 days.
Heritage-Crystal Clean is a leading provider of parts cleaning, used oil re-refining, and hazardous and non-hazardous waste services. This Zacks Rank #2 stock has a Value Score of A.
Heritage-Crystal Clean has an expected earnings growth rate of 26.6% for the current year. HCCI’s earnings beat the Zacks Consensus Estimate in each of the trailing four quarters, the average being 37%.
Sterling Infrastructure specializes in transportation, e-infrastructure and building solutions. This Zacks Rank #2 stock has a Value Score of A.
Sterling Infrastructure has an expected earnings growth rate of 47.4% for the current year. The Zacks Consensus Estimate for STRL’s current-year earnings has been revised 4.6% upward over the past 60 days.
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.
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.
One Tiny Company Could Shake the EV Industry
Zacks Aggressive Growth expert Brian Bolan has pinpointed a U.S. manufacturer with an under-$5 stock price that’s gearing for a monster ride. It’s ramping up production of an affordable, “working man’s” rival to Tesla just as soaring gas prices and desire for energy independence are set to drive the EV market to $1 trillion in 5 years.
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Global Partners LP (GLP): Free Stock Analysis Report
Sterling Infrastructure, Inc. (STRL): Free Stock Analysis Report
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HeritageCrystal Clean, Inc. (HCCI): Free Stock Analysis Report
Innoviva, Inc. (INVA): Free Stock Analysis Report
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