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.
The GARP theory enables strategic mingling of growth and value-investing principles, which gives us a hybrid strategy 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 stocks’ P/E ratio with their 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 10 stocks that qualified the screening:
Academy Sports and Outdoors, Inc. ( ASO Quick Quote ASO - Free Report) is a full-line sporting goods and outdoor recreation retailer in the United States. Academy's product assortment focuses on key categories of outdoor, apparel, footwear and sports & recreation through both leading national brands and a portfolio of 19 private label brands. The stock can be an impressive value investment pick with its Zacks Rank #1 and a Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive fiscal 2022 expected earnings growth rate of 23.8%.
L Brands, Inc. has 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. 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 a solid long-term expected growth rate of 13%. PetroChina Company Limited ( PTR Quick Quote PTR - Free Report) is the largest integrated oil company in China. PetroChina operates in four segments: Exploration & Production, Natural Gas & Pipelines, Refining & Chemicals, and Marketing. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #1. The stock also has a 46.3% earnings growth rate for the next five years. You can see the complete list of today’s Zacks #1 Rank (Strong Buy) stocks here. Laboratory Corporation of America Holdings ( LH Quick Quote LH - Free Report) is a leading healthcare diagnostics company, providing comprehensive clinical laboratory services and end-to-end drug development support. The company had an impressive growth rate of 24.6% for the past five years. The stock currently has a Value Score of A and carries a Zacks Rank #2. Hibbett Inc. ( HIBB Quick Quote HIBB - Free Report) is a major athletic-inspired retailer, located in small and mid-sized markets across the country. The company operates predominantly in the South, Southwest, Mid-Atlantic and Midwest regions of the United States. The stock carries a Zacks Rank of 1 and has a Value Score of B. The company has an impressive long-term expected growth rate of 17.7%.
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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 .