A bull market leads investors to take risks without a second thought. During this phase, strategies based on momentum are the most tempting for all kinds of investors. However, thinking logically, in a bull market, when most stocks are hovering around their potential highs, momentum investing involves the biggest risks and the least returns.
On the contrary, value investment, if implemented well in a bullish market, considering the ‘Margin of Safety’ principle, there are chances of positive outcomes. Margin of safely is basically the difference between the estimated intrinsic value and the market value of a particular stock. A favorable margin of safely is one where the expected intrinsic value is greater than the market value of a stock.
However, calculation of intrinsic value of a stock is quite subjective and any slip may result in “value traps”. To escape such traps, it is vital to determine where the stock is headed in the next 12 to 24 months.
Although there are many value investment yardsticks such as dividend yield, P/E or P/B, which are simple and can single out whether a stock is trading at a discount, at this point, it is more logical for 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 M 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 of the seven stocks that qualified the screening:
Ultra Clean Holdings, Inc. (UCTT - Free Report) : It is a renowned developer and supplier of critical systems and subsystems for the semiconductor capital equipment and flat panel industries. The company offers an integrated outsourced solution for gas delivery systems and other subassemblies, improved design-to-delivery cycle times, component neutral design and manufacturing and component testing capabilities. Ultra Clean Holdings can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score of B. The company’s long-term expected earnings growth rate is projected to be 15%.
Burlington Stores, Inc. (BURL - Free Report) : Headquartered in NJ, this is a nationally recognized off-price retailer. The company offers fashion-focused merchandise, including ladies sportswear, menswear, youth apparel, baby furniture, footwear, accessories, home décor and gifts, and coats. Apart from a Zacks Rank #2 and a Value Style Score of B, the stock also has an impressive long-term expected growth rate of 16.2%.
Zumiez Inc. : Zumiez is a leading specialty retailer of apparel, footwear, accessories and hardgoods for young men and women who want to express their individuality through the fashion, music, art and culture of action sports, streetwear, and other unique lifestyles. The stock also can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 15%.
Signet Jewelers Limited (SIG - Free Report) : This is a leading retailer of diamond jewelry globally. The company operates 3,600 stores primarily under the name brands of Kay Jewelers, Zales, Jared The Galleria Of Jewelry, H.Samuel, Ernest Jones, Peoples and Piercing Pagoda. It has an impressive long-term historical growth rate of 15.6%. It has a Value Style Score of A and carries a Zacks Rank #1. You can see the complete list of today’s Zacks #1 Rank stocks here.
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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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