Tap These 5 Bargain Stocks With Attractive EV-to-EBITDA Ratios

Investors typically have a fixation on the price-to-earnings (P/E) strategy while seeking stocks trading at attractive prices. This straight-forward, easy-to-calculate ratio is the most preferred among all the valuation metrics in the investment toolkit for working out the fair market value of a stock. But even this ubiquitously used valuation metric is not without its pitfalls.

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.

Boise Cascade Company BCC, M/I Homes, Inc. MHO, The ODP Corporation ODP, EnerSys ENS and Plains GP Holdings, L.P. PAGP are some stocks with impressive EV-to-EBITDA ratios.

EV-to-EBITDA is a Better Option, Here’s Why

Also referred to as enterprise multiple, EV-to-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 company.

EBITDA, the other element, 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.

Typically, the lower the EV-to-EBITDA ratio, the more enticing it is. A low EV-to-EBITDA ratio could indicate that a stock is potentially undervalued.

Unlike the P/E ratio, EV-to-EBITDA takes debt on a company’s balance sheet into account. For this reason, it is typically used to value acquisition targets. The ratio shows the amount of debt that the acquirer has to bear. Stocks flaunting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates.

Moreover, P/E 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 that have 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.

But EV-to-EBITDA has its limitations too. The ratio varies across industries (a high-growth industry typically has a higher multiple and vice versa) and is usually not appropriate while comparing stocks in different industries, given their diverse capital requirements.

Thus, instead of just relying on EV-to-EBITDA, you can club 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 bargain 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 11 stocks that passed the screen:

Boise Cascade operates as a wood products manufacturer and building materials distributor. This Zacks Rank #1 stock has a Value Score of A.

The Zacks Consensus Estimate for Boise Cascade’s current-year earnings has been revised 31.6% upward over the past 60 days. BCC’s earnings beat the Zacks Consensus Estimate in three of the last four quarters. It has a trailing four-quarter earnings surprise of roughly 25.5%, on average.

M/I Homes is one of the leading builders of single-family homes. This Zacks Rank #1 stock has a Value Score of A.

The consensus estimate for M/I Homes’ current-year earnings has been revised 34.2% upward over the last 60 days. MHO’s earnings beat the Zacks Consensus Estimate in each of the last four quarters at an average of around 40.4%.

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 #2 stock has a Value Score of A.

ODP has an expected year-over-year earnings growth rate of 18.2% for the current year. The Zacks Consensus Estimate for the company’s current-year earnings has been revised 4% upward over the past 60 days.

EnerSys engages in manufacturing, marketing and distribution of various industrial batteries. This Zacks Rank #2 stock has a Value Score of A.

EnerSys has an expected year-over-year earnings growth rate of 45.7% for the current fiscal year. ENS has surpassed the Zacks Consensus Estimate in each of the trailing four quarters, the average being 10.3%.

Plains GP Holdings, through its subsidiaries, is involved in the transportation, storage, terminalling, and marketing of crude oil and refined products. This Zacks Rank #2 stock has a Value Score of A.

Plains GP Holdings has an expected year-over-year earnings growth rate of 44.2% for the current year. The consensus estimate for PAGP’s current-year earnings has been revised 67.6% upward over the past 60 days.
The ODP Corporation (ODP): Free Stock Analysis Report