Shrugging off inflation fear, the U.S. equity market is chasing new highs. Evidently, mass inoculation, resumption of business activities and return to normal lifestyle to an extent, as well as improving job prospects are all indicative of a rebounding economy. The Fed’s ongoing easy-monetary policy has also been playing a key role. With the economy gradually making its way out of the woods, quite a few market pundits are placing their bets on value stocks.
Value style is considered one of the best practices when it comes to picking stocks. Value investing is essentially about selecting stocks that are fundamentally sound but have been beaten down by some external factors, such as the pandemic. Such stocks are poised to bounce back as and when investors recognize the inherent value of companies. Certainly, value investment strategy suits best to investors having long-term horizon.
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. However, 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. 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 also consider 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 five of the 20 stocks that qualified the screening:
Boise Cascade Company BCC, which manufactures wood products and distributes building materials in the United States and Canada, sports a Zacks Rank #1. It has an expected EPS growth rate of 10.2% for three-five years. The company has a trailing four-quarter earnings surprise of 51.3%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.
Vale S.A. VALE, which produces and sells iron ore and iron ore pellets for use as raw materials in steelmaking, has a Zacks Rank #1 and an expected EPS growth rate of 32.4% for three-five years. The company has a trailing four-quarter earnings surprise of 4.1%, on average.
General Motors Company GM designs, builds, and sells cars, trucks, and automobile parts globally. It has a Zacks Rank #1 and an expected EPS growth rate of 9.9% for three-five years. The company has a trailing four-quarter earnings surprise of 75.8%, on average.
ArcBest Corporation ARCB has an expected EPS growth rate of 22.2% for three-five years and a trailing four-quarter earnings surprise of 618.3%, on average. This provider of freight transportation and integrated logistics services currently carries a Zacks Rank #2.
Atlas Corp. ATCO, which operates as an asset manager and operator, carries a Zacks Rank #2. It has an expected EPS growth rate of 14.5% for three-five years. The company has a trailing four-quarter earnings surprise of 7.2%, on average.
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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.