Thanks to the pandemic-driven market selloffs, a number of growth stocks moved into the undervalued territory. In fact, since the end of 2020, with the emergence of new strains of coronavirus that are claimed to be 56% more contagious, world trade has once again being jeopardized, resulting in disruption of the global supply chain and decline in stock prices.
However, with the ongoing extensive rollout of vaccines across nations as well as the COVID-19 fear factor gradually easing out of the economy, market watchers believe that steep rebounds are in the cards for these beaten-down stocks anytime in 2021.
At this point of time, with many fundamentally great stocks now at their lows, 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 61 stocks that qualified the screening:
PVH Corporation ( PVH Quick Quote PVH - Free Report) : Headquartered in New York, PVH Corporation specializes in designing and marketing branded dress shirts, neckwear, sportswear, jeanswear, intimate apparel, swim products, footwear, handbags and related products. Its brands are sold globally at various price points and in channels of distribution. The company has an impressive long-term expected growth rate of 18%. 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. Albertsons Companies ( ACI Quick Quote ACI - Free Report) : The company through its subsidiaries, operates as a food and drug retailer in the United States. Its food and drug retail stores offer grocery products, general merchandise, health and beauty care products, pharmacy, fuel, and other items and services. 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 12%. Alexion Pharmaceuticals ( ALXN Quick Quote ALXN - Free Report) : Based in New Haven, CT, Alexion Pharmaceuticals is a biopharmaceutical company focused on the development and commercialization of life-transforming drugs for the treatment of patients with ultra-rare disorders. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #2 and has a Value Score of B. Pilgrims Pride Corporation ( PPC Quick Quote PPC - Free Report) : The company is focusing on strengthening its Prepared Foods category. Also, the company has been increasing its product mix for organic category, including No-Antibiotics-Ever products, to cater to customers' evolving tastes. Pilgrims Pride 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 5.6%. AGCO Corporation ( AGCO Quick Quote AGCO - Free Report) : Headquartered in Duluth, GA, AGCO is a leading manufacturer and distributor of agricultural equipment and related replacement parts. The company offers a full product line of farm equipment through a wide network of dealers and distributors across 140 countries. The company holds a Zacks Rank #1 and has a Value Score of A. The stock also has an impressive earnings growth rate of 14.8% 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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