One interesting way to find undervalued stocks is by finding those that do not proportionally increase in price for a given increase in earnings per share (EPS) estimate.
To create this list, we focused on large-cap ($10B-$200B) stocks trading on the U.S. markets. We started with a theoretical observation about P/E ratios.
If the price/earnings per share ratio is equal to some constant K, it follows that there should be a linear relationship between price and earnings per share. In other words:
If P/E = K
then P = (K)(E)
If there is a mismatch between growth rates in projected earnings per share values and price, a mis-pricing may have occurred, presenting an opportunity to value investors.
All of the stocks listed below have seen an increase in the current year EPS analyst projection over the last 30 days. For every stock in this list, the price change has lagged the change in EPS projections. This indicates that these stocks may still have to price in the good news.
Yes, this approach isn't 100% accurate. There is no reason to believe that P/E should be equal to a constant at all times (that is, after all, a simplifying assumption to build a screen). But the goal here is to give you a starting point in finding potentially undervalued stocks.
Would you like to know more about any of the terms used above? Let's review:
Rallying: When a stock is rallying, it means its price is performing above its market average price for a given time period. It is presented as a percentage of price relative to the average (i.e., 10% above the average). When a stock is performing above its 20 day moving average (MA), also known as simple moving average (SMA), as well as its 50 and 200 day moving averages, it signals bullish momentum.
Earnings per share (EPS) is the amount of profit that is allotted to each share of a company after dividends have been paid out. Higher EPS and faster EPS growth are both positive signs of profitability.
EPS = (Net Income-Dividends)/(Outstanding Shares)
Price-to-EPS is one of the most widely used financial ratios. Although P/E values are not constant over time, if EPS is rising faster than price, then the P/E ratio is falling, which could be a sign that the stock is undervalued.
Now that you're armed with information, how do you feel about the following list of stocks? Do you think they have more value to cash in? Will their momentum push them toward their analyst target prices?
Use the list below as a starting point for your own analysis. (Click here to access free, interactive tools to analyze these ideas)
1. Lions Gate Entertainment
2. Retail Opportunity Investments
3. Regeneron Pharmaceuticals
4. Akorn
5. Parker Drilling
6. Fidelity National Financial
7. SM Energy
8. Sunoco Logistics Partners
9. Legacy Reserves
10. Endeavour Silver
Interactive Chart: Press Play to compare changes in analyst ratings over the last two years for the stocks mentioned above. Analyst ratings sourced from Zacks Investment Research.
Kapitall's Becca Lipman does not own any of the shares mentioned above. EPS data sourced from Yahoo! Finance, all other data sourced from Finviz.