Value investors have long looked to the price-to-earnings ratio as a means to finding value stocks. However, Benjamin Graham, long considered to be the "father" of value investing, found that a low price-to-earnings ratio wasn't enough to unearth the true undervalued companies.
Graham combined the low price-to-earnings ratios with the power of growth by using the PEG ratio. The PEG ratio is calculated by taking the price-to-earnings (P/E) ratio and dividing it by the growth rate.
Normally, a stock with a PEG ratio under 1.0 is considered a "value".
With the S&P 500, the Russell 2000 and the Mid-cap 400 trading at new record highs, you might think it would be hard to find ANY value.
Screening for PEG
I created a screen for PEG ratios under 1.0 on Zacks free Custom Screener.
Just this one criteria gave me 372 stocks. That's not too shabby.
But all 372 companies are not necessarily good value stocks. I eliminated companies that had a Zacks rank of 4 or 5, which are Zacks Rank Sells, and only searched for Buy ranked stocks.
I also then considered other fundamentals such as the price-to-sales ratio. I plugged in a P/S ratio under 1.0 which can also mean a company is undervalued.
3 Stocks with Magic PEG Ratios
The following 3 companies stood out because they had both stellar value fundamentals, including a low PEG ratio, and a solid business story, including strong earnings growth.
- Manitex International
- Express Inc.
- General Motors
1. Manitex International, Inc. (MNTX - Free Report)
Manitex manufactures lifting solutions including cranes, reach stackers and container handling equipment, rough terrain forklifts, and indoor electric forklifts. Headquartered in Illinois, it supplies crane parts to customers throughout the world.
It is a micro cap company with a market cap of just $163 million. But analysts expect outsized earnings growth in 2013 and 2014 of 26.5% and 39.2%, respectively.
Even though shares are at a new 52-week high, it has a forward P/E of just 15.5. Combined with the earnings growth, that gives it a PEG ratio under the magic level of 1.0.
PEG ratio: 0.8
P/S ratio: 0.7
Zacks Rank #1 (Strong Buy)
2. Express Inc. (EXPR - Free Report)
Express operates men's and women's apparel stores targeting the 20 and 30-something demographic in the United States, Canada and Puerto. Its 620 stores are located primarily in shopping malls, although you can also find them in some big city neighborhoods.
Express is also a small cap, but at a $1.9 billion market cap, it dwarfs Manitex.
While the company isn't expected to see any earnings growth this fiscal year, it is set to rebound with earnings growth of 13.5% in fiscal 2014.
Compared to the S&P 500, Express is cheap. It has a forward P/E of 13.9 while the index trades at 16.2.
Combined with next year's double digit earnings growth, Express has the magic PEG ratio under 1.0.
PEG ratio: 0.95
P/S ratio: 0.9
Zacks Rank #2 (Buy)
3. General Motors (GM - Free Report)
General Motors produces cars and trucks worldwide. Car sales in the United States are hot and have nearly recovered pre-recession highs.
Earnings growth is expected to be just 4.5% in 2013 but 2014 is expected to see the big turnaround with earnings expected to rise another 34%.
Shares were on a hot streak over the summer, as they soared to new 52-week highs. Still, the stock is cheap, with a forward P/E of 10.6.
That means it has the magic combination of both growth and value which produces a PEG under 1.0.
PEG ratio: 0.8
P/S ratio: 0.4
Zacks Rank #2 (Buy)
Dig Deep for the Magic
It's not that easy in this momentum driven market to find stocks with value AND growth. But if you can find this rare combination, those are stocks you might want to keep on your wish list.
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Tracey Ryniec is the Value Stock Strategist for Zacks.com. She is also the Editor of the Turnaround Trader and Value Investor services. You can follow her on twitter at @TraceyRyniec.