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.

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.  

Hamilton Insurance Group, Ltd. HG, Amplify Energy Corp. AMPY, The ONE Group Hospitality, Inc. STKS, PagSeguro Digital Ltd. PAGS and Pampa Energia S.A. PAM 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 (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. 

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.

Generally, 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.  

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 companies making losses but are EBITDA-positive.

EV-to-EBITDA is also a useful yardstick 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 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 14 stocks that passed the screen:

Hamilton Insurance Group is a specialty insurance and reinsurance company that underwrites risks on a worldwide basis through its fully-owned subsidiaries. This Zacks Rank #1 stock has a Value Score of A. 

Hamilton Insurance Group has an expected year-over-year earnings growth rate of around 60.7% for 2024. The Zacks Consensus Estimate for HG's 2024 earnings has been revised upward by 14.3% over the past 60 days.

The ONE Group Hospitality is a restaurant company that develops and operates a portfolio of high-energy restaurants and lounges, and provides hospitality management services. This Zacks Rank #2 stock has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here.

The ONE Group Hospitality has an expected year-over-year earnings growth rate of 83.3% for 2024. The consensus estimate for STKS's 2024 earnings has been revised upward by 2.3% over the past 60 days.

Amplify Energy is an oil and natural gas company engaged in the acquisition, development, exploitation and production of oil and natural gas properties. This Zacks Rank #2 stock has a Value Score of A. 

The Zacks Consensus Estimate for Amplify Energy's 2024 earnings has been revised upward by 17.4% over the past 60 days. AMPY has a trailing four-quarter earnings surprise of roughly 44.5%, on average.

PagSeguro Digital provides financial technology solutions and services for micro-merchants and small and medium-sized businesses in Brazil and internationally. This Zacks Rank #2 stock has a Value Score of A.

PagSeguro Digital has an expected year-over-year earnings growth rate of 32.1% for 2024. The consensus estimate for PAGS’s 2024 earnings has been revised 11.6% upward over the past 60 days.

Pampa Energia is a leading independent energy-integrated company in Argentina. This Zacks Rank #2 stock has a Value Score of A. 

Pampa Energia has an expected year-over-year earnings growth rate of 43.6% for 2024. PAM beat the Zacks Consensus Estimate in three of the last four quarters. In this time frame, it has delivered an earnings surprise of roughly 81.1%, on average.

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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Pampa Energia S.A. (PAM) : Free Stock Analysis Report

The ONE Group Hospitality, Inc. (STKS) : Free Stock Analysis Report

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Hamilton Insurance Group, Ltd. (HG) : Free Stock Analysis Report

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