A pure-play value investor often misses the chance of betting on stocks that have bright long-term prospects. Similarly, growth investors often end up investing in expensive stocks. These kinds of investments particularly gain significance during economic turbulent periods, minimizing recessionary hurdles. This strategy helps find out all good stocks with solid long-term prospects which become absurdly cheap amid economic woes.
For that reason, some investors have come up to bridge the gap between value and growth with a hybrid strategy of investment. Their theory suggests that the principles of both value and growth strategies need to be combined, in order to make a long-term investment more effective.
Accordingly, GARP (growth at a reasonable price) investment, often known as a special case of value investment, is gaining popularity. What GARPers look for is whether or not the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
And here lies the importance of a not-so-popular fundamental metric, the 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 the 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 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.
However, the question that often arises is whether or not the market has an adequate number of companies that are growing earnings while trading at reasonable valuations? Going by a CFA Institute Blogby Nicolas Rabener, “on average, 38% of all stocks exhibit a PEG ratio below 1, which is more than enough for security selection.”
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 a very high growth rate, followed by a sustainable but lower growth rate over 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 of 29 stocks that qualified the screening:
TEGNA Inc. TGNA is a media company offering high-quality television programming and digital content. TEGNA’s focus on content creation rather than TV broadcasting lowers risk from the cord-cutting threat that is affecting the whole of U.S. Pay-TV industry. The stock can be an impressive value investment pick with its Zacks Rank #1 and a Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 10%. You can see the complete list of today's Zacks #1 Rank stocks here.
Integra LifeSciences IART is one of major players in regenerative medicine. A series of product introductions, particularly in Extremities franchise and strong overseas expansion are expected to add longer-tem value for the company in the days to come. The stock can also be an impressive value investment pick with its Zacks Rank #2 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 14%.
PG&E Corporation PCG is the parent holding company of California’s largest regulated electric and gas utility, Pacific Gas and Electric Company. The stock has a solid portfolio of regulated utility assets that offer a stable earnings base and substantial long-term growth potential. The company has an impressive long-term historical growth rate of 5%. The stock currently has a Value Score of B and carries a Zacks Rank of 2.
CoreLogic, Inc. CLGX is a provider of property information, analytics, and data-enabled software platforms and services. The company charters its vessels primarily pursuant to long-term, fixed-rate, time charters to the world's largest container shipping liners CoreLogic is working on strategic initiatives aimed at long-term growth. It is investing in products and solutions, operational capabilities, technology platforms and infrastructure to build strong strategic client partnerships. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #2, at present.
AmerisourceBergen Corporation ABC pharmaceutical services company will likely benefit over the long term from continued solid organic revenue growth, the World Courier unit and the Specialty distribution business. Currently, the stock carries a Zacks Rank #2 and has a Value Score of A.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
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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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AmerisourceBergen Corporation (ABC) : Free Stock Analysis Report
Integra LifeSciences Holdings Corporation (IART) : Free Stock Analysis Report
Pacific Gas & Electric Co. (PCG) : Free Stock Analysis Report
CoreLogic, Inc. (CLGX) : Free Stock Analysis Report
TEGNA Inc. (TGNA) : Free Stock Analysis Report
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