Bet on 4 Top-Ranked Stocks With Rising P/E

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. Not only low P/E stocks, but also stocks with a rising P/E can fetch strong returns. In this regard, investors can bet on the likes of H World Group Limited Sponsored ADR HTHT, Inovio Pharmaceuticals INO, Nouveau Monde Graphite NMG and Cogent Communications CCOI.

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 price. 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's EPS should be greater than or equal to 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 the 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.

Just these few criteria narrowed down the universe from over 7,700 stocks to just 20.

Here are four out of the 20 stocks:

H World Group Limited Sponsored ADR: The Zacks Rank #2 company is involved in the hotel industry. You can see the complete list of today’s Zacks #1 Rank stocks here.

The average four-quarter earnings surprise of HTHT is 14.52%.

Inovio Pharmaceuticals: The Zacks Rank #2 company is engaged in the discovery, development and delivery of a new generation of vaccines, called DNA vaccines, focused on cancers and infectious diseases.

The average four-quarter earnings surprise of INO is 69.05%.

Nouveau Monde Graphite: The Zacks Rank #1 company is developing advanced carbon-neutral graphite-based material solutions for lithium-ion and fuel cell markets.

The average four-quarter earnings surprise of NMG is 106.17%.

Cogent Communications: The Zacks Rank #2 company is a Tier 1 Internet Service Provider that offers low-cost high-speed Internet access, private network services and colocation center services with ultra-low latency data transmission.

The average four-quarter earnings surprise of CCOI is 28.41%.

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This article originally published on Zacks Investment Research (zacks.com).

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