The investment pattern of new-age investors is gradually tending toward hybrid investment from pure play theories like growth or value. According to them, over the long term, this mixed strategy seeks to offer an ideal investment by utilizing the best features of both value and growth investing.
GARP (growth at a reasonable price) investment, often known as a special case of value investment, is gaining popularity among new generation stakeholders. What GARPers look for is whether the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
GARP investing gives priority to one of the popular value metrics, price/earnings growth (PEG) ratio. Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.
The PEG ratio is defined as: (Price/ Earnings)/Earnings Growth Rate
It relates the stocks’ P/E ratio with future earnings growth rate.
While P/E alone only gives an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps to identify stocks that have solid future potential.
A lower PEG ratio, preferably less than 1, is always better for GARP investors.
Say for example, if a stock's P/E ratio is 10 and expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio that indicates both undervaluation and future growth potential.
Unfortunately, this ratio is often neglected due to investors' limitation to calculate the future earnings growth rate of a stock.
There are some drawbacks to using the PEG ratio though. It does not consider the very common situation of changing growth rates such as the forecast of the first three years at very high growth rate followed by a sustainable but lower growth rate in the long term.
Hence, PEG-based investing can turn out to be even more rewarding if some other relevant parameters are also taken into consideration.
Here are the screening criteria for a winning strategy:
PEG Ratio less than X Industry Median
P/E Ratio (using F1) less than X Industry Median (For more accurate valuation purpose)
Zacks Rank of 1 (Strong Buy) or 2 (Buy) (Whether good market conditions or bad, stocks with a Zacks Rank #1 or #2 have a proven history of success.)
Market Capitalization greater than $1 Billion (This helps us to focus on companies that have strong liquidity.)
Average 20 Day Volume greater than 50,000: A substantial trading volume ensures that the stock is easily tradable.
Percentage Change F1 Earnings Estimate Revisions (4 Weeks) greater than 5%: Upward estimate revisions add to the optimism, suggesting further bullishness.
Value Score of less than or equal to B: Our research shows that stocks with a Style Score of A or B when combined with a Zacks Rank #1, 2 or 3 (Hold) offer the best upside potential.
Here are four stocks that qualified the screening:
Stamps.com STMP: The company provides a complete solution for e-commerce merchants to automate order imports and shipping, manage inventory, and increase sales through customer email marketing and online reviews. The stock can be an impressive value investment pick with its Zacks Rank #1 and Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term historical growth rate of 37%. You can see the complete list of today's Zacks #1 Rank stocks here.
Boise Cascade Company BCC: This is one of the largest producers of engineered wood products and plywood in North America and a leading U.S. wholesale distributor of building products. The stock can also be an impressive value investment pick with its Zacks Rank #1 and Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 7.9%.
Canadian Solar CSIQ: The company manufactures solar photovoltaic modules, provides solar energy solutions and has a geographically diversified pipeline of utility-scale power projects in various stages of development. The company has an impressive long-term expected growth rate of 32%. The stock currently has a Value Score of A and a Zacks Rank #2.
PennyMac Financial Services, Inc. PFSI: This is a specialty financial services firm with a comprehensive mortgage platform and integrated business focused on the production and servicing of U.S. mortgage loans and investment management related to the mortgage market. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #1.
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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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Stamps.com Inc. (STMP) : Free Stock Analysis Report
Boise Cascade, L.L.C. (BCC) : Free Stock Analysis Report
PennyMac Financial Services, Inc. (PFSI) : Free Stock Analysis Report
Canadian Solar Inc. (CSIQ) : Free Stock Analysis Report
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