The popularity of value investing is on the rise. The success of billionaire value investors like Warren Buffett further underscores the fact. Per a July Motley Fool article, over the past 50 years, his conglomerate Berkshire Hathaway’s stock has yielded a compound annual return of 20.8%. This indicates that an investment of $10,000 in 1965 would be worth $88 million today.
Buffett believes that proper understanding of the “intrinsic value” of a stock may ease out many problems with regard to value investment. According to him, going by the fundamentals of value investing while picking undervalued stocks, investors need to focus on their earnings growth potential.
While yardsticks such as dividend yield, the ratio of price to earnings, sales or book value are the most common value investing matrices that can easily single out stocks trading at a discount, these ratios fail to consider the potential of a stock. PEG is the ratio with the earnings growth component in it.
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 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 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 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 16 stocks that qualified the screening:
Lantheus Holdings, Inc. (LNTH - Free Report) : The company develops, manufactures, and commercializes diagnostic medical imaging agents and products for the diagnosis and treatment of cardiovascular and other diseases worldwide. Apart from a Zacks Rank #2 and a Value Score of A, the company also has an impressive expected five-year growth rate of 12.5%.
Jazz Pharmaceuticals Public Limited Company (JAZZ - Free Report) : This is a biopharmaceutical company that identifies, develops, and commercializes pharmaceutical products for various medical needs in the United States, Europe, and internationally. The company has an impressive expected five-year growth rate of 17.5%. The stock currently has a Value Score of B and a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
Gray Television, Inc. (GTN - Free Report) : It is a television broadcast company that owns and operates over 100 television stations and leading digital assets in markets throughout the United States. The company currently holds a Zacks Rank #2 and has a Value Score of A. The company also has an impressive long-term historical growth rate of 24.8%.
Aetna Inc. (AET - Free Report) : This is one of the leading diversified health care benefits companies, offering a broad range of traditional, voluntary and consumer-directed health insurance products and related services. This stock can also be an impressive value investment pick with its Zacks Rank #2 and a Value Score of B. Apart from a discounted PEG and P/E, the stock has an impressive long-term expected growth rate of 11.1%.
Uniti Group Inc. (UNIT - Free Report) : This is an internally managed real estate investment trust. The company is engaged in the acquisition and construction of mission critical communications infrastructure and is also a provider of wireless infrastructure solutions for the communications industry. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #1 and has a Value Score of B.
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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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