5 Value Stocks With Exciting EV/EBITDA Ratios To Scoop Up

The price-to-earnings (P/E) ratio, given its apparent simplicity, is preferred the most among valuation metrics in the investment toolkit for working out the fair market value of a stock. A widely popular approach is to chase stocks that sport a low P/E ratio. However, even this easy-to-compute, broadly used equity valuation multiple suffers a few pitfalls.

Why EV/EBITDA is a Better Alternative?

While P/E is the most commonly used tool for assessing a firm’s value, a more complicated metric called EV/EBITDA does a better job. Also known as the enterprise multiple, EV/EBITDA offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA also has a more complete approach to valuation as it determines the total value of a firm as opposed to P/E, which considers only its equity portion.

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. In essence, it is the entire value of a firm.

The other constituent, EBITDA gives the true picture of a firm’s profitability as it eliminates the impact of non-cash expenses like depreciation and amortization that dilute net earnings.

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.

EV/EBITDA also 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 with a low EV/EBITDA multiple could be seen as attractive takeover candidates.

Another downside of P/E is that it can’t be used to value a loss-making entity. A firm’s earnings are also subject to accounting estimates and management manipulation. EV/EBITDA, in contrast, is less open to manipulation and can also be used to value companies that are making loss but are EBITDA-positive.

EV/EBITDA is also a useful tool in assessing the value of companies that are highly leveraged and have a high degree of depreciation. It also can be used to compare companies with different levels of debt.

But EV/EBITDA has its downsides too. It alone can’t conclusively determine a stock’s inherent potential and future performance. The ratio varies across industries and is generally not appropriate while comparing stocks in different industries given their diverse capital spending requirements.

Thus, instead of just relying 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 results.

Screening Criteria

Here are the parameters to screen for true 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.

Value Score of less than or equal to B: Our research shows that stocks with a Style Score of ‘A’ or ‘B’ when combined with a Zacks Rank #1 or 2 offer the best upside potential.

Here are five of the 14 stocks that passed the screen:

Kelly Services, Inc. (NASDAQ:KELYA) offers temporary office clerical, marketing, professional, technical, light industrial, home care services, management services and other business services to a diversified group of customers. This Zacks Rank #1 stock delivered an average positive earnings surprise of around 17.1% in the trailing four quarters.

M/I Homes, Inc. (NYSE:MHO) is one of the leading builders of single-family homes in the U.S. This Zacks Rank #1 stock has an expected year-over-year earnings growth rate of 36.2% for 2017. You can see the complete list of today’s Zacks #1 Rank stocks here.

General Motors Company (NYSE:GM) is engaged in the designing, manufacturing and retailing of vehicles globally including passenger cars, crossover vehicles, and light trucks, sport utility vehicles, vans and other vehicles. This Zacks Rank #2 stock has an expected earnings per share (EPS) growth rate of 9.2% for 3 to 5 years.

American Equity Investment Life Holding Company (NYSE:AEL) is a full-service underwriter of a broad line of annuity and insurance products, with primary emphasis on the sale of fixed rate and index annuities. This Zacks Rank #2 stock has an expected year-over-year earnings growth rate of 71.2% for 2017.

Synnex Corporation (NYSE:SNX) is a global IT supply chain services company, offering a comprehensive range of services to original equipment manufacturers, software publishers and reseller customers worldwide. This Zacks Rank #2 stock delivered an average positive earnings surprise of 12.2% in the trailing four quarters.

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.

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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.

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General Motors Company (GM): Free Stock Analysis Report

M/I Homes, Inc. (MHO): Free Stock Analysis Report

Synnex Corporation (SNX): Free Stock Analysis Report

American Equity Investment Life Holding Company (AEL): Free Stock Analysis Report

Kelly Services, Inc. (KELYA): Free Stock Analysis Report

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