Value style is considered one of the best practices when it comes to picking stocks. There are different valuation metrics to determine a stock’s inherent strength but a random selection of a ratio cannot serve your purpose if you want a realistic assessment of a company’s financial position. For this, we would suggest Price to Cash Flow (or P/CF) ratio as one of the key metrics.
This metric evaluates the market price of a stock relative to the amount of cash flow that the company is generating on a per-share basis – the lower the number, the better. One of the important factors that make P/CF a highly dependable metric is that operating cash flow adds back non-cash charges such as depreciation and amortization to net income, truly diagnosing the financial health of a company.
Analysts caution that a company’s earnings are subject to accounting estimates and management manipulation. On the other hand, cash flow is reliable. It is net cash flow that unveils how much money a company is actually generating and how effectively management is deploying the same.
Positive cash flow indicates an increase in a company’s liquid assets. It gives the company the means to settle debt, shell out for its expenses, reinvest in its business, endure downturns and finally pay back its shareholders. On the other hand, a negative cash flow implies a decline in the company’s liquidity, which in turn lowers its flexibility to support these moves.
However, an investment decision solely based on the P/CF metric may not fetch the desired results. To identify stocks that are trading at a discount, you should expand your search criteria and take into account price-to-book ratio, price-to-earnings ratio and price-to-sales ratio. Adding a favorable Zacks Rank and a Value Score of A or B to your search criteria should lead to even better results as these eliminate the chance of falling into a value trap.
The Bargain Hunting Strategy
Here are the parameters for selecting true value stocks:
P/CF less than or equal to X-Industry Median.
Price greater than or equal to 5: The stocks must all be trading at a minimum of $5 or higher.
Average 20-Day Volume greater than 100,000: A substantial trading volume ensures that the stock is easily tradable.
P/E using (F1) less than or equal to X-Industry Median: This parameter shortlists stocks that are trading at a discount or are equal to its peers.
P/B less than or equal to X-Industry Median: A lower P/B compared with the industry average implies that there is enough room for the stock to gain.
P/S less than or equal to X-Industry Median: The P/S ratio determines how a stock price compares to the company’s sales — the lower the ratio the more attractive the stock is.
PEG less than 1: The ratio is used to determine a stock's value by taking the company's earnings growth into account. PEG ratio gives a more complete picture than P/E ratio. A value of less than 1 indicates that the stock is undervalued and that investors need to pay less for a stock that has robust earnings growth prospect.
Zacks Rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform irrespective of the market environment.
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 Zacks Rank #1 or 2 offer the best upside potential.
Here are four of the seven stocks that qualified the screening:
American Axle & Manufacturing Holdings, Inc. AXL designs, engineers, validate and manufacture driveline and drivetrain systems, and chassis modules for the automotive industry. The company delivered an average positive earnings surprise of 18.9% in the trailing four quarters and has an expected EPS growth rate of 8.1% for 3-5 years. The company sports a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Blucora, Inc. BCOR, which provides technology-enabled financial solutions, carries a Zacks Rank #2 and has an expected EPS growth rate of 20% for 3-5 years. The company delivered an average positive earnings surprise of 23.7% in the trailing four quarters.
Vishay Intertechnology, Inc. VSH, which manufactures and supplies discrete semiconductors and passive components, delivered an average positive earnings surprise of 6% in the trailing four quarters. It has an expected EPS growth rate of 20.6% for 3-5 years and carries a Zacks Rank #2.
Arrow Electronics, Inc. ARW provides products, services, and solutions to industrial and commercial users of electronic components and enterprise computing. The company has an expected EPS growth rate of 11.4% for 3-5 years and carries a Zacks Rank #2.
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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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