Benzinga - by Zacks, Benzinga Contributor.
Investors generally tend to cling to the price-to-earnings (P/E) metric while looking for bargain stocks. In addition to being a widely used tool for screening stocks, P/E is also a popular metric to work out the fair market value of a company. But even this ubiquitously used valuation multiple has a few limitations.
Although P/E is by far the most popular equity valuation ratio, a more complicated metric called EV/EBITDA does a better job of valuing a firm. Often viewed as a better substitute to P/E, this ratio offers a clearer picture of a company's valuation and its earnings potential.
Navios Maritime Partners L.P. (NYSE: NMM), Costamare Inc. (NYSE: CMRE), The ODP Corporation (NASDAQ: ODP), ADT Inc. (NYSE: ADT) and Portland General Electric Company (NYSE: POR) are some stocks with impressive EV-to-EBITDA ratios.
Is EV-to-EBITDA a Better Substitute to P/E? EV-to-EBITDA is essentially the enterprise value 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 component of the multiple, gives a better idea of a company's profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.
Just like P/E, the lower the EV-to-EBITDA ratio, the more attractive it is. A low EV-to-EBITDA ratio could signal that a stock is potentially undervalued.
EV-to-EBITDA takes into account the debt on a company's balance sheet that the P/E ratio does not. Due to this reason, EV-to-EBITDA is generally used to value the potential acquisition targets as it shows the amount of debt the acquirer has to assume. Stocks boasting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates.
Another shortcoming 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. On the other hand, EV-to-EBITDA is difficult to manipulate and can also be used to value loss-making but EBITDA-positive companies.
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 cannot 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.
A strategy solely based on EV-to-EBITDA might not yield the desired results. However, 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.
Screening Criteria 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.
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: 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 10 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 22.1% for 2024. The Zacks Consensus Estimate for NMM's 2024 earnings has been revised 5.3% upward over the past 60 days.
Costamare is a leading owner and provider of containerships and dry bulk vessels for charter. CMRE, a Zacks Rank #1 stock, has a Value Score of A.
Costamare has an expected year-over-year earnings growth rate of 48.8% for 2024. The consensus estimate for CMRE's 2024 earnings has been revised 12% upward over the past 60 days.
ODP is one of the leading providers of business services and supplies, products and technology solutions to small, medium and enterprise businesses. This Zacks Rank #1 stock has a Value Score of A.
ODP has an expected year-over-year earnings growth rate of 7.7% for 2024. The Zacks Consensus Estimate for the company's 2024 earnings has been revised 5.6% upward over the past 60 days.
ADT provides security and automation solutions for homes and businesses, primarily in the United States and Canada. This Zacks Rank #2 stock has a Value Score of A.
ADT has an expected year-over-year earnings growth rate of 37.3% for 2024. The Zacks Consensus Estimate for ADT's 2024 earnings has been stable over the last 60 days.
Portland General Electric is a vertically integrated electric utility that is engaged in the generation, wholesale purchase and sale, transmission, distribution and retail sale of electricity to customers in Oregon. This Zacks Rank #2 stock has a Value Score of B.
Portland General Electric has an expected earnings growth rate of 29.8% for 2024. The Zacks Consensus Estimate for POR's 2024 earnings has been revised 0.7% upward over the past 60 days.
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.
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