The economy has had a roller-coaster ride so far this year. Starting on an upbeat note, the year took a nasty turn with the novel coronavirus bringing the economy to a standstill. Without doubt, this biological catastrophe has severely impacted industries across the board, taking a toll on employment and household income. Nonetheless, measures undertaken to support households, firms and financial market coupled with the resumption of commercial and industrial activities post the coronavirus lockdown have provided much needed impetus.
The gradual reopening of the economy in a phased manner and stimulus measures undertaken by the government provided a confidence boost to Americans. Per Conference Board data, the Consumer Confidence Index rose to 98.1 in June from a revised reading of 85.9 in May. However, the index still remains below the pre-pandemic levels. Moreover, the market pundits cautioned that the path to recovery looks long and bumpy, given millions of job losses since February, high unemployment rate and resurgence of coronavirus cases.
Well we still don’t know how long this battle with COVID-19 will be. Now the big question is what strategy investors should apply.
Here's an All-Weather Strategy
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 to 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.
You must be wondering why we are considering this when the most widely used valuation metric is Price/Earnings (or P/E). Well, 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 the financial health of a company.
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 is actually generating 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, shell out for its expenses, reinvest in its 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 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 a Zacks Rank #1 or 2 offer the best upside potential.
Here are four of the five stocks that qualified the screening:
Big Lots, Inc. BIG, a discount retailer, has a Zacks Rank #1 and an expected EPS growth rate of 7.1% for 3-5 years. The company has a trailing four-quarter positive earnings surprise of 62.2%, on average. You can see the complete list of today’s Zacks #1 Rank stocks here.
Canadian Solar Inc. CSIQ, which designs, develops, manufactures, and sells solar ingots, wafers, cells, modules, and other solar power products, flaunts a Zacks Rank #1. It has an expected EPS growth rate of 32% for 3-5 years. The company has a trailing four-quarter positive earnings surprise of 79.9%, on average.
Teva Pharmaceutical Industries Limited TEVA develops, manufactures, markets, and distributes generic medicines, specialty medicines, and biopharmaceutical products. This Zacks Rank #2 company has an expected EPS growth rate of 5.9% for 3-5 years. The company has a trailing four-quarter positive earnings surprise of 7.2%, on average.
Teekay Tankers Ltd. TNK, which provides marine transportation services to oil industries, has an expected EPS growth rate of 3% for 3-5 years. This Zacks Rank #2 company has a trailing four-quarter positive earnings surprise of 18%, 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.
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Teva Pharmaceutical Industries Ltd. (TEVA) : Free Stock Analysis Report
Canadian Solar Inc. (CSIQ) : Free Stock Analysis Report
Big Lots, Inc. (BIG) : Free Stock Analysis Report
Teekay Tankers Ltd. (TNK) : Free Stock Analysis Report
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