The price/earnings ratio (P/E) is generally considered by investors as the criterion for assessing the fair market value of a stock. It is preferred by many investors while picking stocks trading at attractive prices. However, even this universally used valuation multiple is not without limits.
While P/E enjoys great popularity among value investors, a less used and more complicated metric called EV-to-EBITDA is sometimes seen as a better alternative. The EV/EBITDA ratio gives a true picture of a company’s valuation and earnings potential. It has a more global approach to evaluation.
UFP Industries, Inc. UPPI, PBF Energy Inc. PBF, Boise Cascade Company BCC, Plains All American Pipeline, LP PAA and Talos Energy Inc. TALO are stocks with impressive EV/EBITDA ratios.
EV to EBITDA is a better option, here’s why
EV to EBITDA is basically 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, debt, and preferred stock less cash and cash equivalents.
EBITDA, the other component of the multiple, gives a better idea of a company’s profitability because it removes the impact of non-cash expenses such as depreciation and amortization that reduce net profit. It is also often used as a cash flow indicator.
Usually, the lower the EV/EBITDA ratio, the more attractive it is. A low EV/EBITDA ratio could be a sign that a stock is potentially undervalued.
However, unlike the P/E ratio, EV/EBITDA takes into account debt on a company’s balance sheet. For this reason, the EV/EBITDA ratio is generally used to assess possible acquisition targets. Stocks with a low EV/EBITDA multiple could be considered potential takeover candidates.
Also, the P/E cannot be used to value a loss-making company. A company’s earnings are also subject to accounting estimates and management manipulation. In contrast, the EV/EBITDA ratio is more difficult to manipulate and can be used to assess companies that have negative net income but are positive on the EBITDA front.
The EV/EBITDA ratio is also a useful tool for assessing the value of highly leveraged and highly amortized companies. Additionally, it can be used to compare companies with different levels of debt.
But EV to EBITDA also has its limits. The ratio varies across industries (a high-growth industry usually has a higher multiple and vice versa) and is generally not appropriate when comparing stocks in different industries given their varying capital needs.
Therefore, instead of just relying on EV to EBITDA, you can combine it with the other major ratios such as price per book (P/B), P/E, and price to sales ( P/S) to achieve the desired results.
Here are the parameters to filter for value stocks:
12 Month EV-to-EBITDA – Most Recent Below Industry Median X: A lower EV/EBITDA ratio represents a cheaper valuation.
P/E using (F1) less than X-Industry Median: This metric filters out stocks that are trading at a discount to their peers.
P/B lower than the X-Industry median: A lower P/B relative to the industry average implies that the stock is undervalued.
P/S lower than the median X-Industry: The lower the P/S ratio, the more attractive the stock, as investors will have to pay a lower 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 industry median X: This metric will help select stocks that have growth rates above the industry median. This is a meaningful indicator, as decent earnings growth always adds to investor optimism.
Average volume over 20 days greater than or equal to 100,000: Adding this metric ensures that stocks can be traded easily.
Current price greater than or equal to $5: This setting will help filter out stocks that are trading at a minimum price of $5 or more.
Zacks rank less than or equal to 2: No selection is complete without the Zacks Ranking, which has been proven since its inception. It’s a fundamental truth that stocks with a Zacks #1 (Strong Buy) or 2 (Buy) ranking have always managed to overcome adversity and outperform the market.
Value score 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 most upside potential.
Here are our five picks from the 12 stocks that made it to the screen:
UFP Industries supplies wood, wood composites and other products to the retail, industrial and construction markets. This rank 1 stock from Zacks has a value score of A.
UFP Industries forecasts a profit growth rate of 23.2% for the current year. The Zacks consensus estimate for UFPI earnings for the current year has been revised up 14% in the past 60 days.
PBF Energy provides finished products including fuel oil, transportation fuels, lubricants and many related products. This Zacks #1 rank stock has a value score of A. You can see the full list of today’s Zacks #1 Rank stocks here.
PBF Energy forecasts a profit growth rate of 955.2% for the current year. PBF’s consensus earnings estimate for the current year has been revised up 13.7% in the past 60 days.
Wooded Waterfall is a manufacturer of wood products and a distributor of building materials. This rank 1 stock from Zacks has a value score of A.
Boise Cascade has an expected earnings growth rate of 14% for the current year. The Zacks consensus estimate for BCC’s earnings for the current year has been revised up 2.1% over the past 60 days.
American Plains Pipeline is involved in the transportation, storage, terminalling and marketing of crude oil, natural gas, natural gas liquids and refined products in the United States and Canada. This rank 1 stock from Zacks has a value score of A.
Plains All American Pipeline forecasts year-over-year earnings growth of 15.8% for the current year. PAA’s consensus earnings estimate for the current year has been revised up 1.9% in the past 60 days.
Talos Energy is engaged in the exploration, development and production of oil and gas properties. This rank 2 action from Zacks has a value score of A.
Talos Energy has an expected earnings growth rate of 6,700% for the current year. The Zacks consensus estimate for TALO’s earnings for the current year has been revised up 14.7% in the past 60 days.
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Plains All American Pipeline, LP (PAA): Free Inventory Analysis Report
UFP Industries, Inc. (UFPI): Free Inventory Analysis Report
PBF Energy Inc. (PBF): Free Stock Analysis Report
Boise Cascade, LLC (BCC): Free Stock Analysis Report
Talos Energy Inc. (TALO): Free Stock Analysis Report
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