Finding out the real worth of a value pick is never a cakewalk. Certainly, the Price-to-Earnings (P/E) ratio provides investors with the easiest option to judge whether a company’s stock price actually justifies its current earnings. However, things are not as simple as they seem and considering P/E ratio alone may turn out to be extremely risky at times.
More elaborately, the P/E ratio, while not taking into account the future growth potential of a stock, may end up convincing us to invest in stocks that are at a discount just because of their poor show. For example, when the markets are weak, most of the fundamentally strong stocks fall within the discounted range in terms of P/E.
This may often lead to “
value traps” — a situation when these value picks start to underperform over the long run as the temporary problems which once drove the share price down turn out to be persistent.
For investors looking to escape such value traps, it is vital to determine where the stock would be headed in the next 12 to 24 months?
Warren Buffett advises these investors to focus on the earnings growth potential of a stock. This is where 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 lower 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 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 four stocks that qualified the screening:
The Chemours Company ( CC Quick Quote CC - Free Report) is a leading player in the field of titanium technologies, fluoroproducts and chemical solutions, catering to a wide range of industries with market-defining products, application expertise and chemistry-based innovations. The company has an impressive expected five-year growth rate of 15.5%. The stock currently has a Value Style Score of ‘B’ and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here . Leucadia National Corporation is a diversified holding company that invests in a broad array of businesses. The company’s financial services businesses and investments include investment banking and capital markets, asset management, foreign exchange trading services, real estate, commercial mortgage banking and servicing and vehicle finance. This Zacks Rank #1 stock also holds a Value Style Score of ‘B’ and hence can be a great value investment pick at the moment. Triton International Ltd ( TRTN Quick Quote TRTN - Free Report) is a developer of the world’s largest lessor of intermodal freight containers and chassis.The company holds a Zacks Rank #1 and has a Value Style Score 'A'. The stock also has an impressive current-year earnings growth rate of 126.7%. United States Steel Corporation ( X Quick Quote X - Free Report) produces flat-rolled and tubular steel products primarily in North America and Europe. It operates through three segments, Flat-Rolled Products, U. S. Steel Europe, and Tubular Products. The stock currently flaunts a Zacks Rank #1 and has a Value Style Score of ‘B’. The company also has an impressive growth rate of 311.7% for the next year.
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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 .
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