During the time of market volatility, investors often rely on value investing rather than other options like growth or momentum. As soon as other investors start selling their stocks at a cheaper rate, value investors take this as an opportunity to pick good stocks at a discounted price.
However, this apparently simple value investment technique has some drawbacks and not understanding the strategy properly may often lead to “value traps”. In such a situation, these value picks start to underperform over the long run as the temporary problems, which once drove the share price down, turn out to be persistent. There are many value investment yardsticks such as dividend yield, P/E or P/B, which are simple and can single out whether a stock is trading at a discount.
However, for investors looking to escape such value traps, it is also vital to determine where the stock is headed in the next 12 to 24 months. Warren Buffett advises these investors to focus on the earnings growth potential of a stock. This is where lies the importance of a not-so-popular value investing metric, the PEG ratio.
The PEG ratio is defined as: (Price/ Earnings)/ Earnings Growth Rate
A lower 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 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 five out of the 26 stocks that qualified the screening:
Nu Skin Enterprises, Inc. NUS: The company develops and distributes anti-aging personal care products and nutritional supplements under the Nu Skin and Pharmanex category brands worldwide. The stock can be an impressive value investment pick with its Zacks Rank #2 and Value Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 8.8%.
Kohl's Corporation KSS: The company is a prominent name in the field of omnichannel retail with more than 1,100 stores in 49 states. Apart from a Zacks Rank #1 and a Value Score of A, the company also has an impressive growth rate of 13.7% for the next fiscal.
Olin Corporation OLN: This global manufacturer and distributor of chemical products operates through three segments - Chlor Alkali Products and Vinyls; Epoxy and Winchester. The company has an impressive long-term growth rate of 13.8%. The stock has a Value Score of A and a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here.
Spirit AeroSystems Holdings, Inc. SPR: The company designs, manufactures, and supplies commercial aero structures worldwide. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #1.
Unum Group UNM: The company provides group and individual disability insurance products and services primarily in the United States and the United Kingdom. The stock carries a Zacks Rank #2 and has a Value Score of A. It also has an impressive earnings growth rate of 20.8% for the next fiscal.
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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.
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Spirit Aerosystems Holdings, Inc. (SPR) : Free Stock Analysis Report
Olin Corporation (OLN) : Free Stock Analysis Report
Nu Skin Enterprises, Inc. (NUS) : Free Stock Analysis Report
Unum Group (UNM) : Free Stock Analysis Report
Kohl's Corporation (KSS) : Free Stock Analysis Report
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