In the equity market, investments always need to be prudently hedged in order to overcome uncertainties and limit losses related to external shocks. 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 47 stocks that qualified the screening:
L Brands, Inc. ( LB Quick Quote LB - Free Report) : L Brands evolved from an apparel-based specialty retailer to a segment leader focused on women’s intimate and other apparel, personal care, beauty and home fragrance products. It sells merchandise through specialty retail stores in the United States, Canada, the United Kingdom, Ireland and Greater China (China and Hong Kong), which are primarily mall-based, and through its websites, catalogue and other channels. The company has an impressive long-term expected growth rate of 13%. The stock carries a Zacks Rank #1 and has a Value Score of A. You can see the complete list of today’s Zacks #1 Rank stocks here. Whirlpool Corporation ( WHR Quick Quote 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 B and holds a Zacks Rank #1. The company also has an impressive long-term expected growth rate of 7.3%. TEGNA Inc. ( TGNA Quick Quote TGNA - Free Report) : 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 #2 and has a Value Score of A. LabCorp ( LH Quick Quote LH - Free Report) : It is a leading healthcare diagnostics company, providing comprehensive clinical laboratory services and end-to-end drug development support. The company currently holds a Zacks Rank #1 and has a Value Score of A. The company also has an impressive expected five-year growth rate of 10.1%. Masco Corporation ( MAS Quick Quote MAS - Free Report) : Headquartered in Taylor, MI, this company manufactures, sells and installs home improvement and building products. Masco operates through two business segments, which are Plumbing Products and Decorative Architectural Products. The company currently holds a Zacks Rank #2 and has a Value Score of B. The company also has an impressive expected five-year growth rate of 16.6%.
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and backtesting software.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
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 .