Value investors with varied risk appetite are unlikely to count on 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) while making investment decisions. This is because they often find this ratio complicated considering the limitations in calculating the future earnings growth potential of a stock.
We note that P/E, P/B or P/S can easily measure whether a stock is at present trading at a discount. However, these fail to give any idea about the future growth trend of a stock. In such a case, even if you buy a stock at less than its fair value, you might still end up paying more.
The PEG ratio on the other hand, with the term ‘growth’ within it, is perfect for accurately calculating the future earnings (EPS) growth rate of a company.
The PEG ratio is defined as: (Price/ Earnings)/ Earnings Growth Rate
A lower PEG ratio is always better for value investors.
While P/E fails to identify a true value stock, PEG helps to 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 for the first three years at a very high 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) 2 (Buy) 3 (Hold) (whether good market conditions or bad, stocks with a Zacks Rank #1 (Strong Buy), #2 (Buy) or #3 (Hold) 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 offer the best upside potential.
Here are five of the eight stocks that qualified the screening:
The Chemours Company (CC - Free Report) : This global chemistry company with leading market positions in titanium technologies, fluoroproducts and chemical solutions currently carries a Zacks Rank #1 and a Value Style Score ‘B’. The company also has an impressive expected five-year growth rate of 15.5%.
Rio Tinto plc (RIO - Free Report) : This popular name in the mining and metals market mines and produces aluminum products, copper, gold, silver, and molybdenum, nickel, and diamonds among others. The company can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score ‘B’. Apart from a discounted PEG and P/E, the stock also has an impressive expected growth rate of 11.5% for the next fiscal.
POSCO (PKX - Free Report) : POSCO is a steel rolled products and plates provider in South Korea and internationally. It has a Value Style Score ‘A’ and an impressive growth rate of 23.5% for the next fiscal. It carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Telenor ASA (TELNY - Free Report) : This provider of telecommunication, data, and media communication services in the Nordics, Central and Eastern Europe, and Asia can also be an impressive value investment pick with its Zacks Rank #2 and Value Style Score ‘A’.
Western Refining, Inc. (WNR - Free Report) : This independent crude oil refining and marketing company holds a Zacks Rank #3 and a Value Style Score ‘A’. The company delivered an earnings surprise of 41.2% in its last reported quarter.
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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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