Pure play growth and value investors have one thing in common – both strategize for long-term investments. Yet, their approach and growth goals make them totally distinct from each other when it comes to stock picking.
During the course of their financial planning and execution, while value investors miss the chance of betting on stocks that have bright long-term prospects, growth investors often end up investing in expensive stocks.
Consequently, investors often wonder whether they should resort to any of these distinctive strategies or follow an approach that combines the best of both. The investing track of the Oracle of Omaha over the past few decades and his gradual shift from being a pure-play value investor to a GARP (growth at a reasonable price) investor might give us all the answers.
In this regard, we should take note that strategic mingling of both growth and value investing principles gives us a mixed investing strategy that is getting popular with each passing day. What GARPers look for is whether the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
And here lies the importance of a not-so-popular fundamental metric, the price/earnings growth (PEG) ratio. Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.
The PEG ratio is defined as: (Price/ Earnings)/Earnings Growth Rate
It relates the stocks P/E ratio with future earnings growth rate.
While P/E alone only gives the idea of stocks, which are trading at a discount, PEG while adding the GROWTH element to it, helps finding those stocks that have solid future potential.
A lower PEG ratio, preferably less than 1, is always better for GARP investors.
Say for example, if a stock’s P/E ratio is 10 and expected long-term growth rate is 15%, the company’s PEG will come down to 0.66, a ratio which indicates both undervaluation and future growth potential.
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 very high growth rates 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 five of the 12 stocks that qualified the screening:
Baxter International Inc. (BAX - Free Report) : It is a renowned medical product company. We believe that Baxter’s expanding product pipeline is a key growth catalyst. Newly-launched products like SIGMA SPECTRUM infusion pump and AMIA APD cycler with SHARESOURCE two-way connectivity are expected to drive top-line growth in the near term. Baxter can be an impressive value investment pick with its Zacks Rank #2 and Value Style Score of ‘B’. The company’s long-term expected earnings growth rate is projected to be 12%.
Coca-Cola FEMSA, S.A.B. de C.V. (KOF - Free Report) : This franchise bottler produces, markets, distributes, and sells Coca-Cola trademark beverages. The company offers a portfolio of products, including sparkling beverages, still beverages, juices, sports, and energy drinks, as well as teas, waters, isotonics, and dairy products. Apart from a Zacks Rank #1 and a Value Style Score of 'B', the stock also has an impressive long-term expected growth rate of 17.5%.
Banco Bilbao Vizcaya Argentaria, S.A. (BBVA - Free Report) : BBVA Compass ranks among the top 25 largest U.S. commercial banks based on deposit market share and ranks among the largest banks in Alabama (2nd), Texas (4th) and Arizona (5th). The stock also can be an impressive value investment pick with its Zacks Rank #2 and Value Style Score of 'B'. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 10.3%.
Fibria Celulose S.A. (FBR - Free Report) : This eucalyptus pulp producer works on meeting the growing global demand for forestry products in a sustainable manner. It has an impressive expected five-year growth rate of 18.4%. It has a Value Style Score of ‘A’ and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Teekay Offshore Partners L.P. (TOO - Free Report) : The company operates in the marine midstream space through its ownership of the general partners and a portion of the outstanding limited partner interests in Teekay LNG Partners L.P. and Teekay Offshore Partners L.P. The company holds a Zacks Rank #1 and has a Value Style Score ‘A’. It also has an impressive expected growth rate of 11.6% for the next fiscal.
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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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