While searching for a suitable investment option, value investors with varied risk appetite are unlikely to consider 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.
However, at a time when volatility strikes every second day, 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.
However, these ratios, while not taking into account the future growth potential of a stock, may end up convincing us to invest in stocks that are at a discount just because of their poor show. This may often lead to “value traps” — a situation when 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.
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.
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) 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 stocks that qualified the screening:
The Chemours Company CC is a leading player in the field of titanium technologies, fluoroproducts and chemical solutions, catering to a wide range of industries with market-defining products, application expertise and chemistry-based innovations. The company has an impressive expected five-year growth rate of 15.5%. The stock currently has a Value Style Score of ‘B’ and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
United States Steel Corporation X produces flat-rolled and tubular steel products primarily in North America and Europe. It operates through three segments, Flat-Rolled Products, U. S. Steel Europe, and Tubular Products. The stock currently flaunts a Zacks Rank #1 and has a Value Style Score of ‘B’. The company also has an impressive growth rate of 310.5% for the current year.
Unilever PLC UL is one of the world’s leading suppliers of Food, Home Care, Personal Care and Refreshment products with sales in over 190 countries. Its leading brand in the U.S. and Canada include Axe, Becel, Ben & Jerry’s, Dove, Lipton, Magnum, Nexxus, Noxzema, Pond’s, and Vaseline among many more. The company 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 12%.
DXC Technology Company DXC is an independent, end-to-end IT services company. The company holds a Zacks Rank #1 and has a Value Style Score 'A'. The stock also has an impressive earnings growth rate of 140.4% for the next year.
Tecnoglass Inc. TGLS manufactures architectural glass, windows, and associated aluminum products for the global commercial and residential construction industries. This stock can also be an impressive value investment pick with its Zacks Rank #1 and a Value Style Score ‘B’. The company’s long-term expected earnings growth rate is 20%.
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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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Tecnoglass Inc. (TGLS): Free Stock Analysis Report
Chemours Company (The) (CC): Free Stock Analysis Report
Unilever PLC (UL): Free Stock Analysis Report
United States Steel Corporation (X): Free Stock Analysis Report
Computer Sciences Corporation (DXC): Free Stock Analysis Report
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