Wall Street took a sigh of relief after the U.S. Senate took measures to resolve the prolonged government shutdown. The move was seen as a key step toward restoring access to official data that had been delayed during the closure. With a potential resolution in sight, investors expected the return of important economic indicators that would guide expectations on inflation, employment and the Federal Reserve’s next actions.
Reflecting this renewed optimism, the major U.S. stock indexes surged. The S&P 500 rose 1.5% to 6,832.43, while the Nasdaq Composite gained 2.3% to 23,527.17, and the Dow Jones Industrial Average increased 0.8% to 47,368.63 yesterday. The strong rebound underscored a renewed confidence that the economic disruptions caused by the shutdown could soon ease.
This change in sentiment boosted the appeal of value stocks, which tend to benefit when economic conditions stabilize and market volatility lessens. When evaluating value stocks, one of the most effective valuation metrics is the Price to Cash Flow (P/CF) ratio.
Companies like Great Lakes Dredge & Dock Corporation GLDD, StoneCo Ltd. STNE, PG&E Corporation PCG and Pan American Silver Corp. PAAS boast a low P/CF ratio. The P/CF ratio 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.
Value investing is considered one of the best practices when it comes to picking stocks. It is essentially about selecting stocks that are fundamentally sound but have been beaten down by some external factors. Such stocks are poised to bounce back as and when investors recognize the inherent value of companies. Certainly, the value investment strategy best suits investors with a long-term horizon.
There are different valuation metrics to determine a stock’s inherent strength. Still, a random selection of a ratio cannot serve your purpose if you want a realistic assessment of a company’s financial position. For this, the Price to Cash Flow ratio is one of the key metrics.
Price-to-Cash-Flow 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 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. However, cash flow is reliable. Net cash flow 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, meet 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.
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 expand your search criteria and also consider 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 chance of falling into a value trap.
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 their 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 Zacks Rank #1 or 2, offer the best upside potential.
Here are four of the 10 value stocks that qualified the screening:
Great Lakes Dredge & Dock, the largest provider of dredging services in the United States, sports a Zacks Rank #1. The company has a trailing four-quarter earnings surprise of 65.5%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.
The Zacks Consensus Estimate for Great Lakes Dredge & Dock’s current financial-year sales and EPS indicates growth of 11.6% and 31%, respectively, from the year-ago period. GLDD has a Value Score of A. Shares of GLDD have risen 0.1% in the past year.
Stone, a leading provider of financial technology and software solutions, carries a Zacks Rank #2. The company has a trailing four-quarter earnings surprise of 9.1%, on average.
The Zacks Consensus Estimate for Stone’s current financial-year sales and EPS calls for growth of 11.8% and 24.4%, respectively, from the year-ago period. STNE has a Value Score of B. Shares of STNE have rallied 47.9% in the past year.
PG&E Corporation, an energy holding company that owns Pacific Gas and Electric Company, carries a Zacks Rank #2. The company has a trailing four-quarter earnings surprise of 0.5%, on average.
The Zacks Consensus Estimate for PG&E Corporation’s current financial-year sales and EPS suggests growth of 6.7% and 10.3%, respectively, from the year-ago period. PCG has a Value Score of A. Shares of PCG have declined 21.9% in the past year.
Pan American Silver, a prominent mining company engaged in the production of silver and gold across the Americas, carries a Zacks Rank #2. The company has a trailing four-quarter earnings surprise of 45.2%, on average.
The Zacks Consensus Estimate for Pan American Silver’s current financial-year sales and EPS implies growth of 23.9% and 173.4%, respectively, from the year-ago period. PAAS has a Value Score of B. Shares of PAAS have surged 70% 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.
Click here to sign up for a free trial to the Research Wizard today.
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.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Pacific Gas & Electric Co. (PCG) : Free Stock Analysis Report
Great Lakes Dredge & Dock Corporation (GLDD) : Free Stock Analysis Report
Pan American Silver Corp. (PAAS) : Free Stock Analysis Report
StoneCo Ltd. (STNE) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
Zacks Investment Research
