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How to find bargain-priced stocks (without using P/E ratio)

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Brian Jackson/Thinkstock

Kelly Brown is an investment analyst at Longview Asset Management Ltd. in Toronto.

What are we looking for?

Canadian companies that are on sale.

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Successful investors use several metrics to identify cheap stocks. The best known is the price-to-earnings, or P/E, ratio. Research has demonstrated that selecting companies trading at a low multiple of their earnings will result in a portfolio that is likely to outperform the market over the next 12 months.

Today, I take a different tack and identify companies trading at a low multiple of their enterprise value (EV) to their earnings before interest and taxes (EBIT). Like the P/E ratio, EV/EBIT provides a good measure of value, but there are important differences between the two.

P/E compares the price of a stock to the company's per share earnings, net of interest and taxes. While this is simple, the result can be muddied by extraordinary items, and by tax regimes and levels of debt.

Looking at EV/EBIT levels the playing field between companies that take on debt and those that don't. EV is equal to the market value of a company's equity, plus all of its interest-bearing debt, less any excess cash. EBIT is earnings before interest and taxes and can be a good proxy for pretax unlevered free cash flow.

The screen

My colleague, Alvin Lau, and I used the S&P Capital IQ Screener to search for Canadian companies with an EV/EBIT multiple of less than 10. We excluded companies with a market capitalization lower than $400-million. We excluded the financial sector as the value of financial companies is best measured by other metrics.

More about S&P Capital IQ

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S&P Capital IQ offers tools for fundamental analysis of global securities as well as idea generation and work flow management. Its Web- and Excel-based platform provides access to information on companies, markets, transactions and people around the world.

What we found

Our screen produced 37 results. We selected the 15 with the lowest EV/EBIT multiples.

Our screen highlights a number of resource companies; however, their performance is tied to unpredictable commodity prices.

Outside of the resources and airline sectors, Torstar Corp., Bird Construction Inc. and Transcontinental Inc. appear to be interesting candidates. But, as always, investors should perform their own research before purchasing any of these stocks.

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