Value investing is gaining popularity by the day. The success of value investors like Warren Buffett further underscores this.
Buffett believes that proper understanding of the “intrinsic value” of a stock makes the task easier. Yardsticks such as dividend yield, the ratio of price to earnings or to book value are the most common forms of intrinsic value calculation, which can easily single out stocks that the market is currently undervaluing.
However, these ratios, while not taking into account the 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 affected the share price, turn out to be persistent.
In such a case, even if you buy a stock at less than its fair value, you might 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 determine the intrinsic value of a stock.
There are some drawbacks of 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 M 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 the 30 stocks that qualified the screening:
Chemours Co (NYSE: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 Score of A and sports a Zacks Rank #1.
Boise Cascade Co (NYSE:BBC) is one of the largest producers of engineered wood products and plywood in North America and a U.S. wholesale distributor of building products. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #1 and a Value Score of B.
Louisiana-Pacific Corporation (NYSE:LPX): This is a renowned building products solutions company that manufactures and delivers advanced engineered and innovative building products. The company has operations in the United States, Canada, Chile and Brazil. The stock also can be an impressive value investment pick with its Zacks Rank #1 and Value Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term historical growth rate of 88%.
Seagate Technology plc (NASDAQ:STX): The company provides data storage technology and solutions in Singapore, the United States, the Netherlands, and internationally. Seagate manufactures and distributes hard disk drives, solid state drives and their related controllers, solid state hybrid drives, and storage subsystems. The company has an impressive expected five-year growth rate of 18.9%. The stock has a Value Score of A and carries a Zacks Rank #1.
Meet Group Inc (NASDAQ:MEET): The company operates a social network for meeting new people primarily on mobile platforms in the United States. The company has an impressive long-term expected growth rate of 20%. The stock has a Value Score of B and a Zacks Rank #2.
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and backtesting software.
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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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