This is an interesting time to look at value investing opportunities. Earnings trends have been difficult and the potential for a “value trap” is high. A value trap is a company that appears to be trading at a discount but is really in jeopardy of seeing earnings and revenues decline or may have debt issues that may force it into bankruptcy.
As you consider whether a company is a value, there’s some different paths you can take. You can focus on the balance sheet and consider the book value of a company and consider how may times the book value the price is trading. This measure is referred to as price-to-book value. The book value is the assets of the company minus the liabilities. While this is an effective measure, it doesn’t account for leverage or profitability.
Another measure includes information included on both the income statement and balance sheet. The measure is similar to P/E but allows for better comparability between companies that have different capital structures. The profitability metric is EBITDA or earnings before interest, taxes, depreciation, and amortization. By incorporating EBITDA and using the enterprise value (EV), you get a better measure for comparing companies. Enterprise value represents the takeover value of the company by including the market value of the company using market cap as well as the value of the debt minus the cash held by the company. By using EV/EBITDA, it creates a metric that is more standardized and provides an ability to compare companies from different sectors.
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Check out these posts on other value opportunities.
The following list of four S&P 500 stocks were ranked based on their EV/EBITDA but included metrics for debt-to-equity of less than 1 and a current ratio of greater than one. This combination provides the ability to look at valuation based on profitability but also includes a liquidity and leverage perspective.
Undervalued Stock #1: Marathon Oil Corp (NYSE: MRO)
Marathon is an energy and natural gas exploration company that produces and markets crude oil, natural gas liquids (NGL) and natural gas. The company has debt-to-equity ratio of 0.46 and a current ratio of 1.32. A value greater than one typically reflects the ability of the company to meet its interest obligations. Its EV/EBITDA of 3.06 is the lowest given the additional restraints outlined above and is below its 10-year median value of 5.1.
MRO has a near-term potential target of $10.
Undervalued Stock #2: Xerox Holdings Corp (NYSE: XRX)
Xerox is a provider of digital print technology and related solutions. The company has debt-to-equity ratio of 0.77 and a current ratio of 1.77. Its EV/EBITDA of 4.53 is the second-lowest value given the additional restraints outlined above and is below its 10-year median value of 7.75. Virtually all of the valuation ratios for XRX are near historic lows in the past 10 years.
XRX has a near-term potential target of $24.
Undervalued Stock #3: ConocoPhillips (NYSE: COP)
ConocoPhillips is an independent energy exploration and production company. The company produces, transports and markets crude oil, natural gas and NGLs. COP has debt-to-equity ratio of 0.48 and a current ratio of 2.16. Its EV/EBITDA of 4.6 is the third-lowest value given the additional restraints outlined above and is below near its 10-year median value of 4.5. Virtually all of the valuation ratios for COP are near historic lows in the past 10 years.
COP has a near-term potential target of $55.
Undervalued Stock #4: BorgWarner Inc (NYSE: BWA)
BorgWarner develops technology engine and drivetrain solutions for combustion, hybrid, and electric vehicles. Their applications include passenger cars, SUVs, vans, light trucks, and medium and heavy-duty trucks and buses. BWA has debt-to-equity ratio of 0.41 and a current ratio of 1.76. Its EV/EBITDA of 4.83 is the fourth-lowest value given the additional restraints outlined above and is below near its 10-year median value of 8.55.
BWA has a near-term potential target of $42.50.