In the equity market, investments need to be prudently hedged 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.
A pure play value investor misses the chance of betting on stocks that have bright long-term prospects. The same way, growth investors often end up investing in expensive stocks. In other words, to make a long-term investment more effective, the principles of both value and growth strategies need to be combined.
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 (
One of the fundamental metrics for finding GARP is the price/earnings growth ratio (PEG). 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 a stock’s P/E ratio with future earnings growth rate.
While P/E alone only gives the idea of stocks, which are trading at a discount, PEG while adding the GROWTH element to it, helps to find those stocks that have 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 which indicates both undervaluation and future growth potential.
Unfortunately, this ratio is often neglected due to investors' limitation 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 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 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 six of the 14 stocks that qualified the screening:
Albertsons Companies, Inc. ( ACI Quick Quote ACI - Free Report) : This is a food and drug retailer that operates stores across 34 states and the District of Columbia with more than 20 well-known banners including Albertsons, Safeway, Vons, Jewel-Osco, Shaw's, Acme, Tom Thumb, Randalls, United Supermarkets, Pavilions, Star Market, Haggen, Carrs, Kings Food Markets and Balducci's Food Lovers Market. 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 long-term expected growth rate of 12%. You can see the complete list of today's Zacks #1 Rank stocks here . Avis Budget Group, Inc. ( CAR Quick Quote CAR - Free Report) : Headquartered in Parsippany, N.J., Avis Budget Group operates as a leading vehicle rental operator in North America, Europe and Australasia with an average rental fleet of nearly 650,000 vehicles. The company is a leading global provider of mobility solutions through its three most recognized brands — Avis, Budget and Zipcar. The stock can also 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 long-term expected growth rate of 57.2%. Ternium S.A. ( TX Quick Quote TX - Free Report) : This is Latin America's leading flat steel producer, with operating facilities in Mexico, Brazil, Argentina, Colombia, the southern United States and Central America. The company offers a broad range of high value-added steel products for customers active in the automotive, home appliances, HVAC, construction, capital goods, container, food and energy industries. The company has an impressive long-term projected growth rate of 17.9%. The stock currently has a Value Score of A and a Zacks Rank #1. Celestica, Inc. ( CLS Quick Quote CLS - Free Report) : The company provides hardware platform and supply chain solutions in North America, Europe, and Asia. The company partners with leading companies in Aerospace and Defense, Communications, Enterprise, HealthTech, Industrial, Capital Equipment, and Energy to deliver solutions for their most complex challenges. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2. HCA Healthcare, Inc. ( HCA Quick Quote HCA - Free Report) : It is the largest non-governmental operator of acute care hospitals in the United States. Headquartered in Nashville, TN, it operates hospitals and related healthcare entities. The stock carries a Zacks Rank #2 and has a Value Score of A. ArcBest Corporation ( ARCB Quick Quote ARCB - Free Report) is a logistics company with creative problem solvers who deliver innovative solutions for customers' supply chain needs. The stock can also 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 long-term expected growth rate of 23.3%.
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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 .