Investors often opt for the stock-picking approach that involves stocks with a low price-to-earnings (P/E) ratio. This strategy is based on the notion that the lower the P/E ratio is, the higher the stock value. The reasoning behind this is straightforward — when a stock's current market price does not adequately reflect its higher earnings, it suggests potential for growth.
But there is more to this whole P/E story. Because not only low P/E, stocks with a rising P/E can also fetch strong returns. In this regard, investors can bet on the likes of American Eagle Outfitters AEO, Groupon GRPN, Nextracker Inc. NXT, ESS Tech GWH and Virgin Galactic SPCE.
Rising P/E: A Useful Tool
The concept is that as earnings rise, so should the price of the stock. As forecasts for expected earnings come in higher, strong demand for the stock should continue to push up its prices. After all, astock's P/E gives an indication of how much investors are ready to shell out per dollar of earnings.
Suppose an investor wants to buy a stock with a P/E ratio of 30. This means that he is willing to shell out $30 for only $1 worth of earnings as he expects earnings of the company to rise at a faster pace in the future owing to strong fundamentals.
So, if the P/E of a stock is rising steadily, it means that investors are assured of its inherent strength and expect some strong positives out of it.
Also, studies have revealed that stocks have seen their P/E ratios jump over 100% from their breakout point in the cycle. So, if you can pick stocks early in their breakout cycle, you can end up seeing considerable gains.
The Winning Strategy
In order to shortlist stocks that are exhibiting an increasing P/E, we chose the following as our primary screening parameters.
EPS growth estimate for the current year is greater than or equal to last year’s actual growth
Percentage change in last year EPS should be greater than or equal zero
(These two criteria point to flat earnings or a growth trend over the years.)
Percentage change in price over four weeks greater than the percentage change in price over 12 weeks
Percentage change in price over 12 weeks greater than percentage change in price over 24 weeks
(These two criteria show that price of the stock is increasing consistently over the said timeframes.)
Percentage price change for four weeks relative to the S&P 500 greater than the percentage price change for 12 weeks relative to the S&P 500
Percentage price change for 12 weeks relative to the S&P 500 greater than the percentage price change for 24 weeks relative to the S&P 500
(Here, the case for consistent price gains gets even stronger as it displays percentage price changes relative to the S&P 500.)
Percentage price change for 12 weeks is 20% higher than or equal to the percentage price change for 24 weeks, but it should not exceed 100%
(A 20% increase in the price of a stock from the breakout point gives cues of an impending uptrend. But a jump of over 100% indicates that there is limited scope for further upside and that the stock might be due for a reversal.)
In addition, we place a few other criteria that lead us to some likely outperformers.
Zacks Rank less than or equal to 2: Only companies with a Zacks Rank #1 (Strong Buy) or 2 (Buy) can get through.
Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.
These few criteria have narrowed down the universe from over 7,700 stocks to just 35.
Here are five out of the 35 stocks:
American Eagle Outfitters: The Zacks Rank #2 company is a specialty retailer of casual apparel, accessories and footwear for men and women aged 15-25 years. You can see the complete list of today’s Zacks #1 Rank stocks here.
The average four-quarter earnings surprise of AEO is 12.04%.
Groupon: The Zacks Rank #2 company offers a marketplace that connects consumers to merchants. The company offers deals through its mobile application and website — groupon.com — in three primary categories: Local, Goods and Travel.
The average four-quarter earnings surprise of GRPN is 107.77%.
Nextracker: The Zacks Rank #2 company is a provider of intelligent, integrated solar tracker and software solutions used in utility-scale and distributed generation solar power plants.
The average four-quarter earnings surprise of NXT is 62.78%.
ESS Tech: The Zacks Rank #2 company designs, builds and deploys iron flow batteries for long-duration commercial and utility-scale energy storage applications.
The average four-quarter earnings surprise of GWH is 17.86%.
Virgin Galactic: The Zacks Rank #2 company is a vertically integrated aerospace company pioneering human spaceflight for private individuals and researchers.
The average four-quarter earnings surprise of SPCE is 18.28%.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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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 options that are 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 options that are mentioned in this material.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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