The Oracle of Omaha’s secret of success is based on the theory that “The best thing that happens to us is when a great company gets into temporary trouble.” Delving deeper into Warren Buffett’s success story, we come across the term “intrinsic value” of a stock that mostly does the trick for investors.

The process is apparently simple. Pick the stocks that are currently undervalued in the market. Yardsticks such as dividend yield, the ratio of price to earnings or to book value are most commonly used to calculate intrinsic value, which indicates whether a stock is trading at a discount.

But will this alone ensure success? What if there is a dearth of catalysts to propel growth even though the stock is cheap? In such a case, if you buy a stock at less than its fair value, you might still end up paying more. To avoid such value traps, Buffett advises investors to focus on the earnings growth potential of a stock. Here lies the importance of a not-so-popular 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 to find the intrinsic value of a stock.

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 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 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 and #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 or 2 offer the best upside potential. 

Here are five of the 13 stocks that qualified the screening:

US Foods Holding Corp. (USFD Quick QuoteUSFD - Free Report) : This renowned food company and foodservice distributor currently carries a Zacks Rank #1 and a Value Style Score ‘A’. The company also has an impressive expected five-year growth rate of 18.6%.

Nippon Telegraph and Telephone Corporation : This popular name in the field of mobile voice related services, IP/packet communications services, telecommunication equipment, system integration, and other telecommunications-related services currently holds a Zacks Rank #1 and has a Value Style score ‘A’. The company also has an impressive expected five-year growth rate of 9.5%.

Urban Outfitters Inc. (URBN Quick QuoteURBN - Free Report) : Based in Philadelphia, PA, this is a lifestyle specialty retailer that offers fashion apparel and accessories, footwear, home décor and gifts products in the U.S., Canada and Europe. Urban Outfitters is currently making all possible efforts to enhance the performance of its brands through store refurbishment and creation of compelling assortments. This stock can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score ‘A’. Apart from a discounted PEG and P/E, the stock also has an impressive expected five-year growth rate of 15%.

Sotheby's : This company is an auctioneer of authenticated fine art, decorative art, jewelry, wine, and collectibles across the globe. It became the first international auction house when it expanded from London to New York. This Zacks Rank #1 and Value Style Score ‘B’ company also has an impressive expected five-year growth rate of 15%. It delivered an earnings surprise of 43.8% in its last reported quarter.

China Petroleum & Chemical Corp. : This is one of the largest petroleum and petrochemical companies in Asia. This stock can also be an impressive value investment pick with its Zacks Rank #1 and Value Style Score ‘B’. The company has an expected five-year growth rate of 12.3%.

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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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