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5 Value Picks With Strikingly Low EV/EBITDA Ratios

Price-to-earnings (P/E), given its apparent simplicity, is preferred by many investors to handpick stocks trading at attractive prices. A widely favored approach by value investors is to chase for stocks that have a low P/E ratio. However, even this straightforward, easy-to-calculate multiple has a few pitfalls.

EV/EBITDA is a Better Approach, But Why?

While P/E is the most commonly used tool for evaluating a firm’s value, another valuation metric called EV/EBITDA works even better. Also known as the enterprise multiple, this ratio is often viewed as a better alternative to P/E as it offers a clearer picture of a company’s valuation and earnings potential. EV/EBITDA also has a more complete approach to valuation as it determines the total value of a firm as opposed to P/E which only considers its equity portion.

EV/EBITDA is the enterprise value (EV) of a stock divided by its earnings before interest, taxes, depreciation and amortization (EBITDA). The first component of the multiple, EV is the sum of a company’s market capitalization, its debt and preferred stock minus cash and cash equivalents.

EBITDA, the other element of the ratio, is a true reflection of a company’s profitability as it removes the impact of non-cash expenses like depreciation and amortization that dilute net earnings. It is also often used as a proxy for cash flows.

Just like P/E, the lower the EV/EBITDA ratio, the more appealing it is. A low EV/EBITDA ratio could be a signal that a stock is potentially undervalued.

Unlike P/E ratio, EV/EBITDA takes debt on a company’s balance sheet into account. Due to this reason, EV/EBITDA is generally used to value potential acquisition targets as it shows the amount of debt the acquirer has to bear. Stocks sporting low EV/EBITDA multiple could be seen as attractive takeover candidates.

Moreover, P/E can’t be used to value a loss-making firm. A firm’s earnings are also subject to...