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Screen of the Week

This week, I'm going to focus on a simple strategy that uses the PEG Ratio for determining a company's undervaluation or overvaluation.

Let's first start with a definition.

A PEG ratio is simply the:

P/E Ratio divided by the Growth Rate

A value of 1 or less is considered good (at par or undervalued), while a value of greater than 1, in general, is not as good (overvalued).

Once again, the PEG Ratio is simply the P/E Ratio divided by the Growth Rate. Many believe this ratio tells a more complete story than just the P/E.

A company with a P/E Ratio of 25 and a Growth Rate of 20 would have a PEG Ratio of 1.25 (25 / 20 = 1.25).

While a company with a P/E Ratio of 40 and a Growth Rate of 50 would have a PEG Ratio of 0.8.

Traditionally, investors would look at the stock with the lower P/E Ratio and deem it a bargain (undervalued). But looking at it closer, you can see it doesn't have the growth rate to justify its P/E.

The stock with the P/E of 40, though, is actually the better bargain since its PEG Ratio is lower (0.8), implying it's undervalued with more potential value. (Undervalued in relation to its projected growth rate.)

In other words, the lower the PEG, the better the value because the investor would be paying less for each unit of earnings growth.

So for this week's screen, we're going to use the PEG ratio to find value.

Let's first start with:

  • Zacks Rank equal to 1
    (Only stocks with a Zacks Rank of a 'Strong Buy' get through.)

  • Average Broker Rating less than or equal to 2.5
    (The brokers have to be on board as well. Only companies in the better part of a Strong Buy or Buy are allowed.)

  • Projected One Year Growth Rate greater than or equal to 20
    (Strong performers are what we're looking for.)

  • PEG Ratio less than 1
    (P/E using F(1) divided by its F(1) projected growth rate.)
    (We're using a classic, text book example to identify undervalued stocks.)

  • Price greater than or equal to $5

  • Avg. 20 Day Volume greater than or equal to 100,000

Here are 5 stocks from this week's list (for Tues, 6/01/10):

(BRCM - Analyst Report) Broadcom Corp.
(KRA - Snapshot Report) Kraton Performance Polymers, Inc.
(NANO - Snapshot Report) Nanometrics Inc.
NVLS Novellus Systems, Inc.
(WHR - Analyst Report) Whirlpool Corp.

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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: http://www.zacks.com/performance.

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