Investors have been agonized by the coronavirus pandemic-triggered market sell offs. However, the benchmark indices touched a fresh high two days back, thanks to the positive sentiment surrounding the news of the U.S. government placing an initial vaccination order of 100 million doses to Pfizer and BioNTech.
Policymakers have left no stone unturned to provide an impetus to the market. The Fed slashed the benchmark interest rate to nearly zero and a quantitative easing program too was announced to increase money supply. President Trump signed economic relief packages to help small businesses, hospitals as well as to boost testing.
Now the big question is which investment strategy can you resort to right now? Some investors have managed to bridge the gap between value and growth with a hybrid strategy of investment called GARP (growth at a reasonable price). 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. This strategy helps to find out stocks with solid long-term prospects that have become absurdly cheap amid economic woes.
GARP, often known as a special case of value investment, is gaining popularity nowadays. What GARPers look for is whether or not the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
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 have been witnessing earnings growth while trading at reasonable valuations? Going by a CFA Institute blog by 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.
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 the 56 stocks that qualified the screening:
Quest Diagnostics ( DGX Quick Quote DGX - Free Report) is one of the largest providers of commercial laboratory services in North America. The company provides lab testing services, primarily to physicians, hospitals, managed care organizations, employers, government institutions, and other independent clinical laboratories. The stock can be an impressive value investment pick with its Zacks Rank #1 and a Value Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 13.2%. You can see the complete list of today’s Zacks #1 Rank stocks here. eBay Inc. ( EBAY Quick Quote EBAY - Free Report) is an online shopping site that allows visitors to browse through available products listed for sale or auction through each company's online storefront. Over the years, the company has evolved from a relatively small community user-based auction site to a worldwide commercial behemoth store. The stock can also be an impressive value investment pick with its Zacks Rank #1 and a Value Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 11.7%. Cisco Systems ( CSCO Quick Quote CSCO - Free Report) is a global IP-based networking company catering to service providers, companies, commercial users and individuals. The company has a strong presence in the router and switch market. The company has an impressive long-term historical growth rate of 8.4%. The stock currently has a Value Score of B and carries a Zacks Rank of 2. Cigna Corporation ( CI Quick Quote CI - Free Report) is a leading provider of insurance and related products and services. It operates through Health Services, Integrated Medical, International Markets, and Group Disability and Other segments. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2, at present. AbbVie Inc. ( ABBV Quick Quote ABBV - Free Report) is one of the world’s leading pharmaceuticals providers. The company has become one of the top-most pharma companies after it acquired Botox maker Allergan in a cash-and-stock deal for $63 billion in May 2020. Currently, the stock carries a Zacks Rank #2 and has a Value Score of A.
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Click here to sign up for a free trial to the Research Wizard today. 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 .