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Chicago, IL – November 11, 2021 – The actions in this week’s article are TravelCenters of America Inc. AT, Academy Sports and Outdoors, Inc. ASO, ASE Technology Holding Co., Ltd. ASX, Universal Insurance Holdings, Inc. Uve and Covenant Logistics Group, Inc. CVLG.
Exploit these 5 advantageous stocks with attractive EV / EBITDA ratios
Price / Earnings (P / E) multiple is popular among investors looking for cheap stocks. Besides being a widely used tool for filtering stocks, P / E is also a popular measure for determining the fair market value of a business. However, even this ubiquitous valuation multiple has some drawbacks.
EV-EBITDA a better option, here’s why
While P / E is the most popular valuation metric, a more complicated multiple called EV-to-EBITDA works even better. Often seen as a better alternative to P / E, it gives a true picture of a company’s valuation and earning potential, and has a more comprehensive approach to valuation. While the P / E takes into account a company’s share of equity, the EV / EBITDA ratio determines its total value.
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, debt, and preferred stock less cash and cash equivalents. In essence, that’s the whole value of a business.
EBITDA, the other component of the ratio, gives a clearer picture of a company’s profitability because it eliminates non-cash expenses like depreciation and amortization that reduce the bottom line. It is also often used as an indicator of cash flow.
Just like the P / E, the lower the EV / EBITDA ratio, the more attractive it is. A low EV / EBITDA ratio could indicate that a stock is potentially undervalued.
EV / EBITDA takes into account a company’s balance sheet debt that the P / E ratio does not take into account. For this reason, the EV / EBITDA ratio is typically used to assess potential acquisition targets, as it indicates the amount of debt that the acquirer has to assume. Equities with a low EV / EBITDA multiple could be seen as attractive candidates for a takeover.
Another disadvantage of P / E is that it cannot be used to value a loss making business. A company’s profits are also subject to accounting estimates and management manipulation. On the other hand, the EV / EBITDA ratio is difficult to manipulate and can also be used to assess companies in loss but with positive EBITDA.
The EV / EBITDA ratio is also a useful yardstick for measuring the value of heavily indebted and heavily impaired companies. Additionally, it can be used to compare companies with different levels of debt.
However, the EV / EBITDA ratio is not without limitations and cannot on its own conclusively determine the inherent potential and future performance of a stock. The multiple varies across industries and is generally not appropriate when comparing stocks of different industries given their varying capital expenditure requirements.
As such, a strategy based solely on the EV / EBITDA ratio might not yield the desired results. But you can combine it with other major ratios in your stock investing toolkit such as price / book (P / B), price / earnings, and price / sell (P / S) to filter the good deals.
For the rest of this article on the screen of the week, please visit Zacks.com at: https://www.zacks.com/stock/news/1826428/tap-these-5-bargain-stocks-with-alluring-ev-to-ebitda-ratios
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