Investors often opt for the stock-picking approach that involves stocks with a low price-to-earnings (P/E) ratio. This strategy is based on the notion that the lower the P/E ratio is, the higher the stock value. The reasoning behind this is straightforward — when a stock’s current market price does not adequately reflect its higher earnings, it suggests a potential for growth.
But there is more to this whole P/E story. Because not only low P/E, stocks with a rising P/E can also fetch strong returns. In this regard, investors can bet on the likes of Nektar Therapeutics (NKTR), Energous (WATT), DocuSign (DOCU), OptiNose (OPTN) and Canadian Solar (CSIQ).
Rising P/E: An Useful Tool
The concept is that as earnings rise, so should the price of the stock. As forecasts for expected earnings come in higher, strong demand for the stock should continue to push up its prices. After all, astock’s P/E gives an indication of how much investors are ready to shell out per dollar of earnings.
Suppose an investor wants to buy a stock with a P/E ratio of 30. This means that he is willing to shell out $30 for only $1 worth of earnings as he expects earnings of the company to rise at a faster pace in the future owing to strong fundamentals.
So, if the P/E of a stock is rising steadily, it means that investors are assured of its inherent strength and expect some strong positives out of it.
Also, studies have revealed that stocks have seen their P/E ratios jump over 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth
Percentage change in last year EPS should be greater than or equal zero
(These two criteria point to flat earnings or a growth trend over the years.)
Percentage change in price over four weeks greater than the percentage change in price over 12 weeks
Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks
(These two criteria show that price of the stock is increasing consistently over the said timeframes.)
Percentage price change for four weeks relative to the S&P 500 greater than the percentage price change for 12 weeks relative to the S&P 500
Percentage price change for 12 weeks relative to the S&P 500 greater than the percentage price change for 24 weeks relative to the S&P 500
(Here, the case for consistent price gains gets even stronger as it displays percentage price changes relative to the S&P 500.)
Percentage price change for 12 weeks is 20% higher than or equal to the percentage price change for 24 weeks, but it should not exceed 100%
(A 20% increase in the price of a stock from the breakout point gives cues of an impending uptrend. But a jump of over 100% indicates that there is limited scope for further upside and that the stock might be due for a reversal.)
In addition, we place a few other criteria that lead us to some likely outperformers.
Zacks Rank less than or equal to 2: Only companies with a Zacks Rank #1 (Strong Buy) or 2 (Buy) can get through.
Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.
Just these few criteria narrowed down the universe from over 7,700 stocks to just 28.
Here are five out of the 28 stocks:
Nektar Therapeutics: It is a biopharmaceutical company, focused on the development of treatments utilizing its PEGylation and advanced polymer conjugate technology platforms. The stock has a Zacks Rank #2. The average earnings surprise of NKTR for the past four quarters is 22.92%.
Energous: The Zacks Rank #2 company is a developer of a disruptive wire-free charging technology.
The average earnings surprise of WATT for the past four quarters is 7.14%.
DocuSign: This Zacks Rank #1 company is a global provider of cloud-based software. The company’s DocuSign Agreement Cloud is a cloud software suite that automates and connects the entire agreement process.
The average earnings surprise of DOCU for the past four quarters is 25.57%.
OptiNose: This Zacks Rank #2 specialty pharmaceutical company is focused on the development and commercialization of products for patients treated by ear, nose and throat or ENT and allergy specialist.
The average earnings surprise of OPTN for the past four quarters is 24.95%.
Canadian Solar: The Zacks Rank #2 company is a vertically integrated manufacturer of silicon ingots, wafers, cells, solar modules (panels) and custom-designed solar power applications.
The average earnings surprise of CSIQ for the past four quarters is 107.4%.
Canadian Solar Inc. (CSIQ): Free Stock Analysis Report
Nektar Therapeutics (NKTR): Free Stock Analysis Report
Energous Corporation (WATT): Free Stock Analysis Report
OptiNose, Inc. (OPTN): Free Stock Analysis Report
DocuSign (DOCU): Free Stock Analysis Report
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This article originally appeared on Zacks
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