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, the quest for a mixed investment strategy led to the introduction of the GARP (growth at a reasonable price) approach. What GARPers look for is whether the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
The price/earnings growth (PEG) ratio is a perfect example of a GARP strategy. 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 to find 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 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) 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 19 stocks that qualified the screening:
Perrigo Company plc (PRGO - Free Report) : The company develops, manufactures, markets, and distributes over-the-counter (OTC) consumer goods and pharmaceutical products worldwide. Apart from a Zacks Rank #2 and a Value Score of B, the stock also has an impressive long-term expected growth rate of 9.6%.
DXC Technology Company (DXC - Free Report) : This is an independent, end-to-end IT services company, primarily providing information technology services and solutions in North America, Europe, Asia, and Australia. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #1.
Koppers Holdings Inc. (KOP - Free Report) : Headquartered in Pittsburgh, PA, Koppers is an integrated global provider of treated wood products, wood treatment chemicals and carbon compounds. The company holds a Zacks Rank #1 and has a Value Score A. It also has an impressive expected growth rate of 18% for the next five years.
PBF Energy Inc. (PBF - Free Report) : The company operates in the field of refining and supply of petroleum products. The company has two segments, Refining and Logistics. The stock has an impressive expected growth rate of 72.5% for the next fiscal. The stock currently has a Value Score of A and a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here.
Triton International Limited (TRTN - Free Report) : The company is engaged in acquisition, leasing, re-leasing, and sale of various intermodal containers and chassis to shipping lines, and freight forwarding companies and manufacturers. The company holds a Zacks Rank #1 and has a Value Score of B. It also has an impressive expected growth rate of 37.5% for the next year.
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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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