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. StoneCo Ltd. STNE, Unum Group UNM, Asbury Automotive Group, Inc. ABG and Magna International Inc. MGA 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 nine stocks that qualified the screening:
StoneCo, a leading provider of financial technology and software solutions, sports a Zacks Rank #1 and has an expected EPS growth rate of 55.2% for three-five years. The company has a trailing four-quarter earnings surprise of 11.8%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for StoneCo’s current financial year sales and EPS suggests growth of 4.4% and 115.2%, respectively, from the year-ago period. STNE has a Value Score of B. Shares of STNE have rallied 39.1% in the past year.
Unum Group, which provides financial protection benefit solutions, carries a Zacks Rank #2 and has an expected EPS growth rate of 8.4% for three-five years. The company has a trailing four-quarter earnings surprise of 18.6%, on average.
The Zacks Consensus Estimate for Unum Group’s current financial year sales and EPS suggests growth of 2.4% and 20.8%, respectively, from the year-ago period. Unum Group has a Value Score of A. Shares of UNM have gained 53.8% in the past year.
Asbury Automotive Group, which operates as an automotive retailer in the United States, carries a Zacks Rank #2. ABG has a Value Score of A and an expected EPS growth rate of 18.5% for three-five years.
Asbury Automotive Group has a trailing four-quarter earnings surprise of 6.6%, on average. Shares of ABG have rallied 29% in the past year.
Magna International, one of the world’s largest suppliers in the automotive space, carries a Zacks Rank #2. It has an expected EPS growth rate of 20.4% for three-five years. The company delivered an earnings surprise of 16.8% in the last reported quarter.
The Zacks Consensus Estimate for Magna International’s current financial year sales and EPS suggests growth of 8.9% and 20.5%, respectively, from the year-ago period. Magna International has a Value Score of A. Shares of MGA have declined 1.6% in the past year.
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 backtest 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.
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