What are we looking for
Continuing our look at measures for value stocks in the Canadian and U.S. markets, we turn to the ratio of enterprise value (EV) to earnings before interest, taxes, depreciation and amortization (EBITDA).
Outperformance in mid-cycle
We first ran this screen 18 months ago, based on research that Brian Belski, chief investment strategist at Oppenheimer & Co., had done on value metrics in the mid-cycle of an economic recovery – a period, lasting up to three years following a recession, in which value stocks are particularly strong performers. He tested nine popular metrics for identifying value stocks, and concluded that during these periods, a low EV/EBITDA offered the second-best risk-adjusted returns. (A low price-to-free-cash-flow ratio, which we looked at Thursday – tgam.ca/DJep – was the top performer.)
Enterprise value is a company's total market capitalization plus debt, minority interest and preferred shares, minus its cash; it provides a more complete measure of a business's total value than market cap alone. Similarly, EBITDA is considered a more pure indication of a company's earnings, since it removes accounting-related decisions. Essentially, EV/EBITDA is a sophisticated version of the price-to-earnings ratio.
In this screen we have used EBITDA based on the trailing 12-month period.
What we found
Battered Research In Motion Ltd. tops the Canadian list. On the one hand, this might mean investors doubt the EBITDA of the past 12 months can be sustained. (That may also be the case for the numerous energy and mining names that are on both the Canadian and U.S. lists, as the sustainability of historically high commodity price levels has come into doubt amid global economic uncertainty.) On the other hand, this may indicate that investors have gone overboard in punishing RIM for its recent disappointments.
Note that several Canadian stocks – WestJet Airlines Ltd., AGF Management Ltd., Transcontinental Inc., Genworth MI Canada Inc. – appeared on both the EV/EBITDA screen and Thursday's P/FCF screen. That's two key metrics by which these stocks look like great values and potential outperformers – certainly making them worth a closer look.