The Federal Reserve succeeded in its bid to tame inflation, as the consumer price index fell 0.1% sequentially in December. With inflation slowing steadily, Fed Chairman Jerome Powell may further reduce the rate of interest rate hikes. Economists expect an increase in the benchmark interest rate by a quarter of a basis point.
Despite cooling inflation, market experts continue to see headwinds in the form of softness in consumer spending. In addition, geopolitical turmoil, as well as higher borrowing costs, may simply push the economy into a likely recession.
So the question is how to refine the portfolio to withstand any unprecedented circumstances. Well, take a holistic approach. Look for stocks that are fundamentally sound and offer security as well as sustainability with long-term upside potential.
Here’s an investment tip
We always try to hit the jackpot while picking stocks. But hitting the right chord every time isn’t easy unless you’re blessed with the Midas touch. When it comes to the investment market, experts believe that the value style is one of the most effective approaches. Value investing is essentially about picking stocks that have good things going for them, even when they’ve been beaten by some external factors.
There are various valuation metrics to determine the intrinsic strength of a stock, but a random selection of ratios cannot serve your purpose if you want a realistic assessment of a company’s financial health. For this, we recommend price to cash flow (or P/CF) as one of the key metrics. This metric evaluates the market price of a stock relative to the amount of cash flow the company generates on a per-share basis—the lower the number, the better. Signet Jewelers Limited (I SAY – Free report), NRG Energy, Inc. (NRG – Free report), ACCO Brands Corporation (ACCO – Free report) and Sterling Infrastructure, Inc. (SIZE – Free report) boast a low P/CF ratio.
Cost to cash flow reveals financial health
One may question why we are considering the price-to-cash flow metric when the most widely used metric is price/earnings (or P/E). Well, what sets P/CF apart is that operating cash flow adds back non-cash charges like depreciation and amortization to net income, which truly reflects the company’s financial health.
Analysts warn that the company’s earnings are subject to accounting estimates and management manipulation. However, cash flow is reliable. Net cash flow reveals how much cash a company actually generates and how effectively management uses it.
Positive cash flow indicates an increase in the company’s liquid assets. This gives the company the means to settle debts, pay for its expenses, reinvest in its business, weather downturns, and finally pay back its shareholders. On the other hand, negative cash flow implies a drop in the company’s liquidity, which in turn reduces its flexibility to support these moves.
What is the best strategy?
An investment decision based solely on the P/CF ratio may not yield the desired results. To identify stocks that are trading at a discount, you should broaden your search criteria and also consider price-to-book, price-to-earnings, and price-to-sales ratios. Adding a favorable Zacks Rank and a Value assessment of A or B to your search criteria should result in even better results as they eliminate the chance of falling into a value trap.
Here are the parameters for choosing true value stocks:
P/CF less than or equal to X-industry median.
Price greater than or equal to 5: All shares must trade at a minimum of $5 or more.
Average 20-day volume over 100,000: The significant trading volume ensures that the shares are easily tradable.
P/E using (F1) less than or equal to X-Industry Median: This parameter includes stocks that are trading at a discount or equal to their peers.
P/B is less than or equal to X-Industry Median: A lower P/B compared to the industry average means there is plenty of room for the stock to gain.
P/S less than or equal to X-Industry Median: The P/S ratio determines how the share price compares to the company’s sales – the lower the ratio, the more attractive the stock.
PEG less than 1: The ratio is used to determine the value of the stock, taking into account the company’s profit growth. The PEG ratio presents a more complete picture than the P/E ratio. A value less than 1 indicates that the stock is undervalued and that investors should pay less for a stock that has solid earnings growth prospects.
Zacks Rank Less Than or Equal to 2: Stocks with a Zacks Rank #1 (Strong Buy) or 2 (Buy) are known to outperform regardless of the market environment.
A value score less than or equal to B: Our research shows that stocks with a style rating of A or B, when combined with a Zacks Rank #1 or 2, offer the best upside potential.
Here are four of the eight stocks that meet the screening criteria:
print, the world’s largest diamond jewelry retailer, has a Zacks Rank #1. It has an expected EPS growth rate of 8% over three to five years. You can see the full list of today’s Zacks #1 Rank stocks here.
Signet has an earnings surprise over the last four quarters of an average of 44.8%. SIG has a value of B. The stock is down 11.9% over the past year.
NRG Energy operates as an integrated energy company in the United States. This Zacks Rank #1 company has an expected EPS growth rate of 12.1% over three to five years. NRG Energy has an A value rating.
The Zacks Consensus Estimate for NRG Energy’s current fiscal year sales and EPS suggests year-over-year growth of 19.9% and 45.9%, respectively. Shares of NRG are down 13.4% over the past year.
ACCO brands, which designs, manufactures and sells consumer and consumer products, carries a Zacks Rank #2. The company has an expected EPS growth rate of 12% over three to five years.
ACCO Brands has a value rating of A. The company’s earnings surprise for the last four quarters averaged 6.2%. Shares of ACCO Brands have fallen 24.6% over the past year.
Sterling Infrastructure, which deals in transportation, electronic infrastructure and construction solutions, carries a Zacks Rank #2. It has an expected EPS growth rate of 18% over three to five years. The company has surprising earnings for the past four quarters averaging 20%.
The Zacks Consensus Estimate for Sterling Infrastructure’s current fiscal year sales and EPS suggests year-over-year growth of 21.2% and 46.1%, respectively. Sterling Infrastructure has a value rating of A. Shares have jumped 30% 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 of the Research Advisor and start using this screen in your own trading. Moreover, you can also create your own strategies and test them first before taking the investment leap.
The Research Advisor is a great place to start. It is easy to use. Everything is in understandable language. And it’s very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open the research wizard, plug in your findings and see what gems come out.
Click here to sign up for a free trial of Research Advisor 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 the options 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 the options mentioned in this material.
Disclosure: Information on the performance of Zacks portfolios and strategies is available at: https://www.zacks.com/performance.