As per data provided by a Forbes article, shares of Berkshire Hathaway, owned by the world’s most successful value investor Warren Buffett, increased 20% in 2016, boosting the Oracle of Omaha’s personal fortune by $12.3 billion (more than any other billionaire in the U.S.) to $74.2 billion. This once again underscores the importance of value investing as the most tempting strategy to bet on even amid uncertain market conditions.
While searching for a suitable investment option, value investors with varied risk appetite are most unlikely to hit upon the price/earnings to growth (PEG) ratio among a number of other popular metrics like price/earnings (P/E), price/sales (P/S) or price/book value (P/B). This is because they often find this ratio complicated, considering the limitations in calculating the future earnings growth potential of a stock.
But, in a year full of volatility, it is pointless to ponder on methods which don’t consider a stock’s future growth rate while calculating its intrinsic merit. Yardsticks such as dividend yield, P/E or P/B are most commonly used to single out whether a stock is trading at a discount.
But will a discount based on these multiples ensure success? What if there is a dearth of catalysts to propel growth even though the stock is at a discount right now? In such a case, even if you buy a stock at less than its fair value, you might still end up paying more. And here comes the importance of this not-so-popular but crucial value investing metric, the PEG ratio.
The PEG ratio is defined as: (Price/ Earnings)/Earnings Growth Rate
A low PEG ratio is always better for value investors.
While P/E alone fails to identify a true value stock, PEG helps to find the intrinsic value of a stock.
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 doesn’t consider the very common situation of changing growth rates such as the forecast of the first three years at a 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 some of 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), 2 (Buy), 3 (Hold) (whether good market conditions or bad, stocks with a Zacks Rank #1, #2 or #3 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 or 2 offer the best upside potential.
Here are five of the seven stocks that qualified the screening:
Teck Resources Limited TECK: This popular name in the field of natural resources with its business spread across the Americas, the Asia Pacific, and Europe currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive growth rate of 162.2% for the next year.
AK Steel Holding Corporation AKS: Headquartered in West Chester, OH (Greater Cincinnati), this is a producer of flat-rolled carbon, stainless and electrical steel products, and carbon and stainless tubular products. The company primarily serves automotive, infrastructure and manufacturing, construction and electrical power generation and distribution markets. This stock can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score ‘A’. Apart from a discounted PEG and P/E, the stock also has an impressive expected growth rate of 217% for 2017.
Cosan Limited CZZ: Cosan Limited was established as the controlling shareholder of Cosan S.A., a Brazilian company that is engaged in the cultivation, harvesting and processing of sugarcane, the main raw material used for producing sugar and ethanol. The company has an impressive expected five-year growth rate of 16.3%. The stock currently has a Value Style Score of ‘A’ and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
KB Financial Group Inc. KB: This financial holding company, providing various banking and related financial services in South Korea and internationally, currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive expected five-year growth rate of 8.4%.
Validus Holdings, Ltd. VR: This is a holding company for reinsurance and insurance operating companies and investment advisors including Validus Reinsurance, Ltd. This stock can also be an impressive value investment pick with its Zacks Rank #1 and a Value Style Score ‘B’. The company’s 2017 expected earnings growth rate is 11.7%.
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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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KB Financial Group Inc (KB): Free Stock Analysis Report
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