Investors have been agonized by the coronavirus pandemic-triggered market sell offs. In September so far, all the benchmarks have declined, thanks to the ongoing tech-driven sell offs. Also, market watchers’ apprehension about a ‘new great depression’ approaching has resulted in bearishness.
At this point of time, the big question is which investment strategy can you resort to right now? With many fundamentally great stocks now at their historical lows on a series of production and supply halts worldwide, investors searching for a suitable investment option may currently resort to value investment to capitalize on the long-term potential of these stocks.
However, this apparently simple-to-understand investing discipline has its own share of pitfalls. Value investors, while betting on stocks, often fall prey to companies that have weak prospects. 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 drove the share price down, turn out to be persistent.
And here comes the importance of this not-so-popular but crucial value investing metric, price/earnings to growth (PEG) ratio.
While searching for a suitable value investment option, investors are unlikely to consider this ratio among a number of other popular value metrics like price/earnings (P/E), price/sales (P/S) or price/book value (P/B). This is because they often find this ratio complicated, considering the limitations in calculating the future earnings growth potential of a stock.
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 to find the intrinsic value of a stock.
There are some drawbacks to using the PEG ratio though. 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 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 some of 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 52 stocks that qualified the screening:
Hanesbrands Inc. (HBI - Free Report) : The company engages in the design, manufacture, sourcing and sale of apparel essentials for men, women and children in the United States and internationally. Its popular brands are Hanes, Champion, Playtex, Bali, Just My Size, Barely There and Wonderbra. The company has an impressive long-term expected growth rate of 5.4%. The stock carries a Zacks Rank #1 and has a Value Score of B. You can see the complete list of today’s Zacks #1 Rank stocks here.
Whirlpool Corporation (WHR - Free Report) : This is one of the largest manufacturers of home appliances in the world. The company manufactures products in 14 countries and markets products in nearly every country around the world. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2. The company also has an impressive long-term expected growth rate of 16.6%.
TEGNA Inc. (TGNA): This is a leading U.S. broadcasting groups and a local news and media content provider. The company operates 62 television stations in 51 U.S. markets, catering to 39% of TV households in the United States. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #1 and has a Value Score of A.
Fresenius Medical Care (FMS - Free Report) : This is one of the leading integrated providers of products and services for individuals undergoing dialysis following chronic kidney failure. The company currently holds a Zacks Rank #2 and has a Value Score of A. The company also has an impressive expected five-year growth rate of 7.7%.
Regal Beloit (RBC - Free Report) : This company is a leading manufacturer of electrical and mechanical motion control products. The company offers an array of electric motors, blowers, electric generators, transfer switches, gearboxes, power generation components and controls. The company holds a Zacks Rank #1 and has a Value Score of B. The stock also has an impressive earnings growth rate of 10.8% for the next five years.
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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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