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 a bargain. However, even this straightforward, broadly used valuation metric has a few downsides.
Although 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.
The Greenbrier Companies, Inc. GBX, Molson Coors Beverage Company TAP, PRA Group, Inc. PRAA, El Pollo Loco Holdings, Inc. LOCO and Gibraltar Industries, Inc. ROCK are some stocks with attractive EV-to-EBITDA ratios.
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 by removing the impact of non-cash expenses like depreciation and amortization that dampen net earnings. It is also often used as a proxy to 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 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.
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 tool in measuring the value of firms that are highly leveraged and have a high degree of depreciation. It can also be used to compare companies with different levels of debt.
EV-to-EBITDA is not devoid of limitations 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.
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.
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.
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: 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 25 stocks that passed the screen:
The Greenbrier Companies is a leading supplier of transportation equipment and services to the railroad and related industries. This Zacks Rank #1 stock has a Value Score of A.
The Greenbrier Companies has an expected year-over-year earnings growth rate of 18.9% for fiscal 2025. The consensus estimate for GBX’s fiscal 2025 earnings has been revised 13.5% upward over the past 60 days.
Molson Coors is a global manufacturer and seller of beer and other beverage products with an impressive diverse portfolio of owned and partner brands. This Zacks Rank #1 stock has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.
Molson Coors has an expected year-over-year earnings growth rate of 6.5% for 2025. The consensus estimate for TAP’s 2025 earnings has been revised 6.4% upward over the past 60 days.
PRA Group is a global financial and business services company in the Americas, Australia and Europe. This Zacks Rank #1 stock has a Value Score of B.
PRA Group has an expected year-over-year earnings growth rate of 26.3% for 2025. The consensus estimate for PRAA’s 2025 earnings has been revised 12.4% upward over the past 60 days.
El Pollo Loco develops, franchises, licenses and operates quick-service restaurants under the name El Pollo Loco. This Zacks Rank #2 stock has a Value Score of A.
El Pollo Loco has an expected year-over-year earnings growth rate of 14.5% for 2025. The Zacks Consensus Estimate for LOCO’s 2025 earnings has been revised 2.2% upward over the past 60 days.
Gibraltar Industries manufactures and distributes products and services to the industrial and buildings market. This Zacks Rank #2 stock has a Value Score of B.
Gibraltar Industries has an expected year-over-year earnings growth rate of 15.5% for 2025. The consensus estimate for ROCK’s 2025 earnings has been revised 1% upward over the past 60 days.
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PRA Group, Inc. (PRAA) : Free Stock Analysis Report
Molson Coors Beverage Company (TAP) : Free Stock Analysis Report
Gibraltar Industries, Inc. (ROCK) : Free Stock Analysis Report
Greenbrier Companies, Inc. (The) (GBX) : Free Stock Analysis Report
El Pollo Loco Holdings, Inc. (LOCO) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
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