In a market dealing with external shocks, value investing is fast gaining popularity. The success of value investors like Warren Buffett underscores this. Buffett and his business partner, Charlie Munger, managed to register more than 20% CAGR for Berkshire Hathaway from 1965 through 2022. This compares favorably with a 10% rise of the S&P 500 Index during the same period.

Several other stocks, which have surged significantly in the recent past, have shown the overwhelming success of this pure-play investment strategy. Here we discuss five such stocks — Toll Brothers, Inc. (TOL Quick QuoteTOL - Free Report) , Urban Outfitters Inc. (URBN Quick QuoteURBN - Free Report) , StoneCo (STNE Quick QuoteSTNE - Free Report) , OSI Systems, Inc. (OSIS Quick QuoteOSIS - Free Report) and American Woodmark Corporation (AMWD Quick QuoteAMWD - Free Report) .

More on Value Investing

While searching for a suitable investment option, value investors with a varied risk appetite are unlikely to consider price/earnings to growth (PEG) ratio among several other popular metrics like price/earnings (P/E), price/sales and price/book value (P/B).

This is because they often find this ratio complicated, considering the limitations in calculating a stock's future earnings growth potential. Yardsticks, such as dividend yield, P/E or P/B, are commonly used to single out stocks trading at a discount.

However, while not taking into account the growth potential of a stock, these ratios 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. 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 the five stocks that qualified the screening:

Toll Brothers: Based in Horsham, PA, Toll Brothers builds single-family detached and attached home communities; master planned luxury residential resort-style golf communities; and urban low, mid, and high-rise communities, principally on the land it develops and improves. Toll Brothers mostly offers luxury homes and its communities are located in prosperous suburban areas with easy access to major cities.

Toll Brothers currently holds a Zacks Rank #1 and has a Value Score of B. Toll Brothers also has an impressive five-year historical growth rate of 23.9%. You can see the complete list of today’s Zacks #1 Rank stocks here.

Urban Outfitters: Based in Philadelphia, PA, Urban Outfitters is a lifestyle specialty retailer that offers fashion apparel and accessories, footwear, home décor and gift products. The company’s merchandise is generally sold directly to consumers through stores, catalogs, call centers and e-commerce platforms. The company has operations in the United States, Canada and Europe.

Apart from a discounted PEG and P/E, URBN currently has a Zacks Rank #1 and a Value Score of A. Urban Outfitters has a long-term expected growth rate of 23.7%.

StoneCo: It is a leading provider of financial technology and software solutions that empower merchants to conduct commerce seamlessly across multiple channels and help them grow their businesses. It distributes its solutions, principally through proprietary Stone Hubs, which offer hyper-local sales and services, and sells solutions to brick-and-mortar and digital merchants through a sales team.

StoneCo has an impressive long-term expected growth rate of 55.2%. StoneCo currently has a Value Score of A and a Zacks Rank of 2.

OSI Systems: The company is a vertically integrated designer and manufacturer of specialized electronic systems and components for critical applications in the homeland security, healthcare, defense, and aerospace industries. OSI Systems combines more than 40 years of electronics engineering and manufacturing experience with offices and production facilities in more than a dozen countries to implement a strategy of expansion into selective end-product markets. 

Apart from a discounted PEG and P/E, OSIS currently has a Zacks Rank #2 and a Value Score of B. OSI Systems has a long-term expected growth rate of 11%.

American Woodmark: The company manufactures and distributes kitchen, bath, office, home organization, and hardware products for remodeling and new home construction markets in the United States. American Woodmark offers made-to-order and cash-and-carry products. It also provides turnkey installation services to its direct builder customers through a network of eight service centers.

American Woodmark has a long-term expected growth rate of 13%. AMWD currently carries a Zacks Rank of 1 and has a Value Score of A.

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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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