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.
Navios Maritime Partners L.P. NMM, Hewlett Packard Enterprise Company HPE, Aegon N.V. AEG, Cowen Inc. COWN and Sanofi SNY are some stocks with attractive 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 tool in measuring 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 50,000: 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 eight stocks that passed the screen:
Navios Maritime Partners is an international owner and operator of dry cargo vessels. This Zacks Rank #1 stock has a Value Score of A.
Navios Maritime Partners has an expected earnings growth rate of 38.8% for 2023. The Zacks Consensus Estimate for NMM’s 2023 earnings has been revised 14.4% upward over the past 60 days.
Hewlett Packard Enterprise, carrying a Zacks Rank #2, is focused on developing solutions that allow customers to capture, analyze and act upon data seamlessly from edge to cloud. You can see the complete list of today’s Zacks #1 Rank stocks here.
Hewlett Packard Enterprise has a Value Score of A. HPE has a trailing-four quarter earnings surprise of 3.3%, on average.
Aegon is an integrated international financial services group offering investment, protection and retirement solutions. This Zacks Rank #2 stock has a Value Score of A.
Aegon has an expected year-over-year earnings growth rate of 1,500% for 2023. The Zacks Consensus Estimate for AEG’s 2023 earnings has been revised 6.1% upward over the last 60 days.
Cowen provides investment banking, equity research, sales and trading, prime brokerage, global clearing, commission management services and actively managed alternative investment products globally. This Zacks Rank #2 stock has a Value Score of A.
Cowen has an expected earnings growth rate of 69.8% for 2023. The consensus estimate for COWN’s 2023 earnings has been revised 0.2% upward over the past 60 days.
Sanofi manufactures and markets prescription drugs in Europe, the United States and other countries. SNY, a Zacks Rank #2 stock, has a Value Score of B.
Sanofi has an expected year-over-year earnings growth rate of 2.1% for 2023. The Zacks Consensus Estimate for SNY’s 2023 earnings has been revised 2.3% upward over the last 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.
Click here to sign up for a free trial to the Research Wizard today.
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.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report