As we navigate the second half of 2023, the stock market presents a surprising picture of resilience and momentum. Inflation, which has long been a concern for investors and consumers alike, is showing signs of abating. Economic growth has not only defied initial fears but has also exceeded expectations. The banking sector, having weathered a regional crisis that sent shockwaves through the financial world, is now showing renewed confidence.
The Federal Reserve has played a pivotal role in steering the economy, with a strategic focus on stabilizing prices. In recent months, the central bank has taken measures to address inflationary pressure by raising the benchmark interest rate. While a section of experts still believes that the Fed may continue to raise rates to bring inflation back to 2%, other looming concerns include a potential government shutdown in October, a geopolitical tussle with China and rising oil prices.
In such a scenario, it may be prudent to revisit your investment strategy. We believe investment in stocks made on diligent value analysis is usually considered one of the best practices. In value investing, investors pick stocks that are cheap but fundamentally sound. There are a number of ratios to identify value stocks but none alone can conclusively determine their inherent potential. Each ratio helps an investor understand a particular aspect of the company’s business.
One such ratio, Price to Cash Flow (or P/CF) can work wonders in stock picking if used prudently. 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. Select Medical Holdings Corporation SEM, EnerSys ENS, O-I Glass, Inc. OI and PagSeguro Digital Ltd. PAGS boast a low P/CF ratio.
Why P/CF Ratio?
You must be wondering why we are considering this when the most widely used valuation metric is Price/Earnings (or P/E). Well, an important factor that makes 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 a company’s financial health.
Analysts caution that a company’s earnings are subject to accounting estimates and management manipulation. Then again, cash flow is quite reliable. Net cash flow unveils how much money a company generates and how effectively management is deploying the same.
A positive cash flow indicates an increase in the company’s liquid assets. This gives the company the means to settle debt, meet its expenses, reinvest in the business, endure downturns and finally undertake shareholder-friendly moves. Negative cash flow implies a decline in the company’s liquidity, which, in turn, lowers its flexibility to support these endeavors.
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 the 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 chances 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. The PEG ratio gives a more complete picture than the 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 prospects.
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 a Zacks Rank #1 or 2 offer the best upside potential.
Here are four of the seven stocks that qualified the screening:
Select Medical Holdings, one of the largest operators of critical illness recovery hospitals, rehabilitation hospitals, outpatient rehabilitation clinics and occupational health centers, carries a Zacks Rank #2. The company has an expected EPS growth rate of 23.4% for three to five years.
The Zacks Consensus Estimate for Select Medical Holdings’ current financial year sales and EPS suggests growth of 4.2% and 56.9%, respectively, from the year-ago period. SEM has a Value Score of A. Shares of SEM have risen 4.5% in the past six months.
EnerSys, the global leader in stored energy solutions for industrial applications, carries a Zacks Rank #2 and has an expected EPS growth rate of 14% for three to five years. The company has a trailing four-quarter earnings surprise of 10.3%, on average.
The Zacks Consensus Estimate for EnerSys’ current financial year sales and EPS suggests growth of 3.8% and 45.7%, respectively, from the year-ago period. ENS has a Value Score of A. Shares of ENS have advanced 17.5% in the past six months.
O-I Glass, one of the leading producers of glass bottles and jars around the globe, carries a Zacks Rank #2. O-I Glass has a Value Score of A and an expected EPS growth rate of 15% for three to five years.
O-I Glass has a trailing four-quarter earnings surprise of 20.5%, on average. Shares of OI have declined 13.4% in the past six months.
PagSeguro Digital, which provides financial technology solutions and services, carries a Zacks Rank #2. It has an expected EPS growth rate of 9.9% for three to five years. The company has a trailing four-quarter earnings surprise of 9.3%, on average.
The Zacks Consensus Estimate for PagSeguro Digital’s current financial year sales and EPS suggests growth of 3.6% and 13%, respectively, from the year-ago period. PagSeguro Digital has a Value Score of A. Shares of PAGS have risen 7% in the past six months.
O-I Glass, Inc. (OI): Free Stock Analysis Report
This article originally appeared on Zacks
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