In a market hurt by external shocks, value investing is fast gaining popularity. The success of value investors like Warren Buffett further underscores this. Buffett and his business partner, Charlie Munger managed to register 20% compound annual growth in the market value of Berkshire Hathaway from 1965 through 2020 compared with 10.2% rise of the S&P 500 during the same period.
However, while searching for a suitable investment option, value investors with varied risk appetite are unlikely to consider price/earnings to growth (PEG) ratio among a number of other popular 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. Yardsticks, such as dividend yield, P/E or P/B, are most commonly used to single out stocks trading at a discount.
However, these ratios, which do not takeinto account the future growth potential of a stock, might end up convincing us to invest in stocks that are at a discount just because of their poor show. This might often lead to “value traps” — a situation when these value picks start to underperform over the long run as the temporary problems, which once pulled down the share price, turn out to be persistent.
In such a case, even if you buy a stock at less than its fair value, you might still end up paying more. And here comes the importance of this not-so-popular but crucial value investing metric, the PEG ratio.
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 find the intrinsic value of a stock.
There are some drawbacks to using the PEG ratio though. It doesn’t 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 over 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 seven out of the 20 stocks that qualified the screening:
ArcBest Corporation ( ARCB Quick Quote ARCB - Free Report) : The company provides freight transportation and integrated logistics services. It operates through three segments: Asset-Based, ArcBest, and FleetNet. ArcBest has a long-term historical growth rate of 23.3%. The stock currently carries a Zacks Rank of 1 and has a Value Score of A. 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%. Juniper Networks, Inc. ( JNPR Quick Quote JNPR - Free Report) : Sunnyvale, CA based Juniper Networks is a leading provider of networking solutions and communication devices. The company develops, designs and sells products that help to build network infrastructure used for services and applications based on single Internet protocol network worldwide. Apart from a discounted PEG and P/E, the stock currently sports a Zacks Rank #2 and has a Value Score of B. Celestica, Inc. ( CLS Quick Quote CLS - Free Report) : The company provides hardware platform and supply chain solutions in North America, Europe, and Asia. Through its recognized customer-centric approach, the company partners with players in Aerospace and Defense, Communications, Enterprise, HealthTech, Industrial, Capital Equipment, and Energy to deliver solutions for their most complex challenges. It has a long-term expected growth rate of 10.2%. The stock currently has a Value Score of A and carries a Zacks Rank of 2. Lincoln National Corporation ( LNC Quick Quote LNC - Free Report) : Headquartered in Philadelphia, PA, this is a diversified life insurance and investment management company. One of the key differentiators at Lincoln is its strong distribution franchise. The company currently holds a Zacks Rank #2 and has a Value Score of A. It also has an impressive five-year expected growth rate of 40.1%. Capri Holdings Limited ( CPRI Quick Quote CPRI - Free Report) : The company provides women’s and men’s accessories, footwear and ready-to-wear, as well as wearable technology, watches, jewelry, eyewear and a full line of fragrance products. It operates in the global personal luxury goods industry. Apart from a discounted PEG and P/E, the stock currently has a Zacks Rank #2 and a Value Score of A. It also has an impressive five-year expected growth rate of 19.8%. Tempur Sealy International, Inc. ( TPX Quick Quote TPX - Free Report) : The company together with its subsidiaries, develops, manufactures, markets, and distributes bedding products in the United States, Canada, and internationally. It currently holds a Zacks Rank #2 and has a Value Score of B. It also has an impressive five-year expected growth rate of 21.5%.
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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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