In the equity market, investments always need to be prudently hedged in order to overcome uncertainties and limit losses related to external shocks. A question that arises often is whether one should resort to a value strategy that seeks discounted stocks or opt for growth investing in times of extreme market instability.
The investing track of the Oracle of Omaha over the past few decades and his gradual shift from being a pure-play value investor to a GARP (growth at a reasonable price) investor might give us all the answers.
Under the GARP theory, the strategic mingling of growth and value-investing principles gives us a hybrid strategy, offering an ideal investment by utilizing the best features of both. What GARPers look for is whether or not the stocks are somewhat undervalued and have solid sustainable growth potential (
GARP investing gives priority to one of the popular value metrics — 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 rates.
While P/E alone gives an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps identify stocks with 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 the expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio indicating both undervaluation and future growth potential.
Unfortunately, this ratio is often neglected due to investors' limitations to calculate the future earnings growth rate 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 very high growth rate, followed by a sustainable but lower growth rate over the long term.
Hence, PEG-based investing can 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 out of the 45 stocks that qualified the screening:
Based in New Haven, CT,
Alexion Pharmaceuticals, Inc. ( ALXN Quick Quote ALXN - Free Report) is a biopharmaceutical company focused on the development and commercialization of life-transforming drugs for the treatment of patients with ultra-rare disorders. The company’s complement franchise consists of key growth driver, Soliris, which is approved for the treatment of two severe and ultra-rare disorders resulting from chronic uncontrolled activation of the complement component of the immune system — paroxysmal nocturnal hemoglobinuria (PNH) and atypical hemolytic uremic syndrome (aHUS). The stock can be an impressive value investment pick with its Zacks Rank #2 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 19.4%.
Based in Kenilworth, NJ,
Merck & Co., Inc. ( MRK Quick Quote MRK - Free Report) boasts more than six blockbuster drugs in its portfolio with PD-L1 inhibitor, Keytruda, approved for several types of cancer, alone accounting for more than 25% of its pharmaceutical sales. The stock can also be an impressive value investment pick with its Zacks Rank #2 and Value Score of B. Apart from a discounted PEG and P/E, the stock also has a solid long-term historical growth rate of 8%. TEGNA Inc. ( TGNA Quick Quote TGNA - Free Report) is one of the largest U.S. broadcasting groups. It operates 62 television stations in 51 U.S. markets, catering to 39% of TV households in the United States. TEGNA’s TV stations, which are also available digitally, reach about 50 million consumers on air and about 35 million digitally each month. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. Sally Beauty Holdings, Inc. ( SBH Quick Quote SBH - Free Report) is an international specialty retailer and distributor of professional beauty supplies. It is one of the largest distributors of beauty products in the United States. The company has an impressive growth rate of 30.6% for the next five years. The stock currently has a Value Score of A and carries a Zacks Rank #2. Huntsman Corporation ( HUN Quick Quote HUN - Free Report) is among the world's largest manufacturers of differentiated and commodity chemical products. The company markets its products to a diverse group of industrial and consumer customers. Its products include MDI, polyols, propylene oxide, amines, surfactants, maleic anhydride, epoxy-based polymer formulations, textile chemicals and dyes. The stock carries a Zacks Rank of 1 and has a Value Score of B.
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Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance .