Stuck to Low P/E? Gain More from 3 Stocks with Rising P/E

The common investing mantra is to chase stocks with a low price-to-earnings (P/E) ratio. That's because this basic measure of how much investors are spending for $1 worth of earnings speaks of undervaluation. The logic is simple – a stock's current market price does not justify its higher earnings and therefore leaves room for upside.

But have you ever given it a thought that stocks with a rising P/E can also be worth buying. We'll tell you why.

Power of Increasing P/E

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 followingas 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 to the previous year

(These two criteria point to a positive or flat earnings growth trend over the years).

Percentage change in price over four weeks greater than 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 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 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 percentage price change for 24 weeks, but it should not exceed 100%

(This criterion indicates that 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 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 equal to 1: Only companies with a Strong Buy rating can get through.

Average 20-day Volume greater than or equal to 50,000: High trading volume implies that the stocks have adequate liquidity.

Just these few criteria narrowed down the universe from over 7,700 stocks to around 3.

Here are the stocks that made it through the screen:

Stamps.com Inc. STMP:  Thisis a provider of Internet-based services for mailing or shipping letters, and packages or parcels. The stock's average earnings surprise over the trailing four quarters is 56.61%.

ReneSola Ltd. SOL: Headquartered in Jiashan, the People's Republic of China, this solar power products company'saverage earnings surprise over the trailing four quarters is 232.9%.

Danaos Corporation DAC:  This is a leading international owner of containerships with an average earnings surprise of 16.82% over the trailing four quarters.

The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.

Click here to sign up for a free trial to the Research Wizard 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 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

Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »

Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
 
DANAOS CORP DAC: Free Stock Analysis Report
 
STAMPS.COM INC STMP: Free Stock Analysis Report
 
RENESOLA LT-ADR SOL: Free Stock Analysis Report
 
To read this article on Zacks.com click here.
 
Zacks Investment Research