5 Value Stocks With Exciting EV-to-EBITDA Ratios to Scoop Up

Anindya Barman
7 min read

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Investors generally tend to cling to the price-to-earnings (P/E) metric while looking for bargain stocks. In addition to being a widely used tool for screening stocks, P/E is also a popular metric to work out the fair market value of a company. But even this ubiquitously used valuation multiple has a few downsides.

While P/E is the most popular valuation metric, a more complicated multiple called EV-to-EBITDA works even better. Often considered a better alternative to P/E, it gives the true picture of a company’s valuation and earnings potential and has a more complete approach to valuation. While P/E considers a firm’s equity portion, EV-to-EBITDA determines its total value.

Nomad Foods Limited NOMD, El Pollo Loco Holdings, Inc. LOCO, KB Home KBH, Columbia Banking System, Inc. COLB and Pampa Energia S.A. PAM are some stocks with attractive EV-to-EBITDA ratios.

Is EV-to-EBITDA a Better Substitute to P/E?

EV-to-EBITDA is essentially the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). EV is the sum of a company’s market capitalization, debt and preferred stock minus cash and cash equivalents. EBITDA, the other component, gives a better idea of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that reduce net earnings. It is also often used as a proxy for cash flows.

The lower the EV-to-EBITDA ratio, the more appealing it is. A low EV-to-EBITDA ratio indicates that a stock is potentially undervalued. EV-to-EBITDA takes into account the debt on a company’s balance sheet, which the P/E ratio does not. For this reason, EV-to-EBITDA is generally used to value potential acquisition targets as it shows the amount of debt the acquirer has to assume. Stocks boasting a low EV-to-EBITDA multiple could be seen as attractive takeover candidates.

Another shortcoming of P/E is that it can’t be used to value a loss-making firm. A company’s earnings are also subject to accounting estimates and management manipulation. On the other hand, EV-to-EBITDA is difficult to manipulate and can also be used to value loss-making but EBITDA-positive companies. EV-to-EBITDA is also a useful yardstick for measuring the value of firms that are highly leveraged and have a high degree of depreciation. It can also be used to compare companies with different levels of debt.

But EV-to-EBITDA has its limitations, too. The ratio varies across industries (a high-growth industry typically has a higher multiple and vice versa) and is usually not appropriate while comparing stocks in different industries, given their diverse capital requirements.

A strategy solely based on EV-to-EBITDA might not yield the desired results. You can club it with the other major ratios in your stock-investing toolbox, such as price-to-book (P/B), P/E and price-to-sales (P/S) to screen value stocks.

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