For generations, value investors have looked to the price-to-earnings ratio, or P/E, 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 and the NASDAQ trading at new all time highs, you might think it would be hard to find ANY value but it does still exist if you dig deep.
Screening for PEG
I created a screen for PEG ratios under 1.0 on
Zacks free Custom Screener.
Just this one criteria gave me 348 stocks. That's not too shabby.
But that doesn't mean all 348 companies are necessarily the companies I want to be buying right now. A list that big is somewhat unruly and isn't small enough to give me the truly best companies.
Therefore, I eliminated companies that had a Zacks rank of 4 or 5, which are Zacks Rank Sells, and only searched for Buy ranked stocks which are Zacks Rank #1 (Strong Buy) or #2 (Buy).
Stocks with Zacks Ranks of #1 (Strong Buy) or #2 (Buy) usually have rising earnings estimates. That's a criteria that I want my companies to have.
That screen gave me 59 results which was more manageable.
Adding Another Top Value Criteria
I decided to add another layer of value on top of that screen, though, because I wanted to find the very top value stocks, which also have growth.
Therefore, I also searched for companies with a price-to-sales (P/S) ratio under 1.0. Companies with a low P/S are usually undervalued compared to the rest of the market.
The P/S ratio is also a great value component to look at to find those companies that are really cheap.
While companies can find a penny here or there for the earnings component of a quarterly earnings report, and therefore "beat" the estimates, it's hard to fudge sales numbers.
Adding the P/S ratio under 1.0 gave me 30 stocks.
3 Stocks with Magic PEG Ratios
Now comes the hard part, of actually narrowing down the 30 stock to just 3.
1. The Chemours Company ( CC - Snapshot Report)
Chemours makes performance chemicals. The company has 37 production facilities in 12 countries in three segments: Titanium Technologies, Fluoroproducts and Chemical Solutions.
It recently celebrated its first year as a public company as it was spun off from DuPont in 2015.
Chemours is in the middle of a 5-Point Transformation Plan. It sold its Sulfur business for $325 million and announced the sale of its Clean and Disinfect business for $230 million.
Everyone in the industry is raising prices of their TiO2 so that is creating a boost for earnings. Analysts have been raising 2016 and 2017 estimates.
Earnings for 2017 are expected to jump 73.5%.
Magic PEG ratio = 0.9
P/S ratio = 0.4
Zacks Rank #2 (Buy)
2. Party City Holdco Inc. ( PRTY - Snapshot Report)
Party City is the largest party goods company be revenue in North America and the largest vertically integrated supplier of decorated party goods globally by revenue.
It designs, manufactures and sources party goods, including paper and plastic tableware, balloons, Halloween costumes, accessories, novelties and party gifts.
Party City operates 730 corporate stores and 183 franchise stores for a total store count of 913.
Party City isn't seeing the consumer slowdown like other retailers. Party goods normally see steady demand and the company said they are "generally unaffected by economic conditions."
Apparently, if you're going to throw a 40th birthday party, you're going to do it no matter what.
Revenue jumped 4.8% in the second quarter with comparable sales up 3.8% driven by strong summer/graduation sales and larger than average purchases.
Additionally, Easter was shifted to the first quarter this year which boosted the quarter as the company shuts its stores on Easter Sunday.
Earnings are expected to rise 21% this year and 12% again next year.
Magic PEG ratio = 1.00
P/S ratio = 0.9
Zacks Rank #2 (Buy)
3. Tower International, Inc. ( TOWR - Snapshot Report)
Tower makes engineered automotive structural metal components and assemblies including frames and chassis structures for cars and trucks.
It has a global business although it intends to sell its remaining business interests in China and Brazil shortly.
The company is benefiting from higher US truck demand. In the second quarter earnings report, it maintained its full year guidance.
Still, investors are worried about North American auto weakness and that there is peak auto. That's why the shares are so cheap.
Analysts aren't as pessimistic, as they see another 13% earnings growth in 2017.
Magic PEG ratio = 0.7
P/S ratio = 0.2
Zacks Rank #2 (Buy)
Want Even More Stocks with Magic PEG Ratios?
The magic PEG ratio is explored in this recent Value Investor Podcast.
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