The US economy made a strong comeback in the third quarter, with GDP up 2.6%, according to the “preliminary” estimate released by the Bureau of Economic Analysis. The positive reading on the economic front has eased long-standing fears of a recession, at least for now. Wall Street also seems a bit confident now after a dismal show in the first three quarters of 2022.
But does sustained economic growth seem plausible from now on? Inflationary pressures, rising interest rates and ongoing geopolitical tensions are enough to derail the momentum. We note that the rate of consumer spending slowed in the last quarter. So, while you modify your portfolio to deal with the changing market scenario and the continued tightening of monetary policy, market pundits are betting on value stocks.
Investing in stocks made on a diligent analysis of value is generally considered one of the best practices. In value investing, investors choose cheap but fundamentally sound stocks. There are a number of ratios to identify stocks of value, but none alone can conclusively determine their inherent potential.
Each ratio helps an investor understand a particular aspect of the company’s business. Such a report Price to cash flow (or P/CF), can do wonders in stock picking if used with caution. This measure assesses the market price of a stock relative to the amount of cash flow the company generates per share – the lower the number, the better. Unum Group (MNU – free report), AerCap Holdings S.A. (ARE – free report), Heritage-Crystal Clean, Inc. (HCCI – free report) and Sterling Infrastructure, Inc. (LSTR – Free report) show a low P/CF ratio.
Why the P/CF ratio?
You must be wondering why we are considering this when the most widely used valuation measure is price/earnings (or P/E). Well, one of the important factors that makes P/CF a very reliable measure is that operating cash flow adds non-cash charges such as depreciation and amortization to net profit, truly diagnosing financial health. from a company.
Analysts warn that a company’s earnings are subject to accounting estimates and management manipulation. Again, the cash flows are quite reliable. Net cash flow reveals how much cash a company generates and how efficiently management deploys it.
A positive cash flow indicates an increase in the company’s liquidity. This gives the company the means to settle its debts, meet its expenses, reinvest in the company, withstand downturns and finally take actions favorable to shareholders. A negative cash flow implies a decrease in the company’s liquidity, which, in turn, reduces its flexibility to support these efforts.
However, an investment decision based solely on the P/CF metric may not yield the desired results. To identify stocks that are trading at a discount, you should broaden your search criteria and consider price-to-book ratio, price-to-earnings ratio, and price-to-sales ratio. Adding a favorable Zacks Rank and an A or B value score to your search criteria should lead to even better results, as it eliminates the chance of falling into a value trap.
The bargain hunting strategy
Here are the real value stock selection parameters:
P/CF less than or equal to the X-Industry median.
Price greater than or equal to 5: The stocks must all trade at a minimum of $5 or more.
Average volume over 20 days greater than 100,000: Substantial trading volume ensures that the stock is easily tradable.
P/E using (F1) less than or equal to X-Industry Median: This setting preselects stocks that are trading at a discount or equal to its peers.
P/B less than or equal to the X-Industry median: A lower P/B relative to the industry average implies that there is enough room for the stock to win.
P/S less than or equal to X-Industry Median: The P/S ratio determines how a stock’s price compares to the company’s sales – the lower the ratio, the more attractive the stock.
PEG less than 1: The ratio is used to determine the value of a stock taking into account the company’s earnings growth. The PEG ratio gives a more complete picture than the P/E ratio. A value below 1 indicates the stock is undervalued and investors should pay less for a stock that offers strong earnings growth prospects.
Zacks rank less than or equal to 2: Zacks Rank #1 (Strong Buy) or 2 (Buy) stocks are known to outperform regardless of the market environment.
Value score 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 most upside potential.
Here are four of the 14 actions that qualified the screening:
Unum Group, which provides financial protection benefit solutions, carries a No. 2 Zacks rank and has an expected EPS growth rate of 12.2% over three to five years. The company has a four-quarter earnings surprise of 34.9% on average. You can see the full list of today’s Zacks #1 Rank stocks here.
Zacks’ consensus estimate for Unum Group’s current-year sales and EPS suggests growth of 0.6% and 42.3%, respectively, over the prior-year period. Unum Group has a value score of A. Shares of UNM have gained 60.4% over the past year.
AerCap, a global leader in aircraft leasing, holds a No. 2 Zacks rank. It has an expected EPS growth rate of 8.2% over three to five years. The company has an earnings surprise for the last four quarters of 24.9% on average.
Zacks’ consensus estimate for AerCap’s current year sales and EPS suggests growth of 35% and 14%, respectively, over the prior year period. AER has a value score of A. The stock is down 9.5% over the past year.
Legacy-Crystal Clean, a leading provider of parts cleaning, used oil refining, hazardous and non-hazardous waste disposal, emergency and spill response, and industrial and field services, carries a rank Zacks No. 2. It has an expected EPS growth rate of 15% over three to five years. The company has an earnings surprise for the last four quarters of 37% on average.
Zacks’ consensus estimate for Heritage-Crystal’s sales and EPS for the current fiscal year suggests growth of 35% and 26.6%, respectively, over the prior year period. Heritage-Crystal has a value score of A. The stock has fallen 15.2% over the past year.
Sterling Infrastructure, which is engaged in transportation, e-infrastructure and building solutions, carries a No. 2 Zacks rank. It has an expected EPS growth rate of 18% over three to five years. The company has a four-quarter earnings surprise of 20%, on average.
Zacks’ consensus estimate for Sterling Infrastructure’s current-year sales and EPS suggests growth of 21.2% and 47.4%, respectively, over the prior-year period. Sterling Infrastructure has a value score of A. The stock has jumped 14.6% over the past year.
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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 the options mentioned herein. An affiliated investment advisory firm may hold or have shorted securities and/or hold long and/or short positions in options mentioned herein.
Disclosure: Information on the performance of Zacks portfolios and strategies is available at: https://www.zacks.com/performance.