With externalities impacting stock markets every second day, investors with varied risk appetite prefer to go for value investing. In the event of a market crash, investors often end up to selling their holdings in a panic. But Warren Buffett advises investors to grab the opportunity and buy bargain stocks at cheap prices. However, this apparently simple-to- understand investing discipline has historically shown dangerous outcomes owing to people’s oversight of the basics.
Warren Buffett believes that proper understanding of the “intrinsic value” of a stock will make the task easier. Yardsticks such as dividend yield, the ratio of price to earnings or to book value are the most common forms of intrinsic value calculation, which can easily single out the stocks that the market is currently undervaluing. However, these ratios fail to consider the future potential of a stock. And here comes the importance of a not-so-popular value investing metric, the PEG ratio. This ratio with earnings growth component in it may help to determine the prospects of a stock.
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), 2 (Buy) or 3 (Hold) (whether good market conditions or bad, stocks with a Zacks Rank #1, #2 and #3 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 or 2 offer the best upside potential.
Here are five of the 12 stocks that qualified the screening:
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 Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 9.2%.
Cosan Limited (CZZ - Free Report) : Cosan was established as the controlling shareholder of Cosan S.A., a Brazilian company that is engaged in the cultivation, harvesting and processing of sugarcane, the main raw material used for producing sugar and ethanol. The company has an impressive expected five-year growth rate of 25%. The stock has a Value Score of A and carries a Zacks Rank #1.
Teck Resources Limited (TECK - Free Report) : This popular name in the field of natural resources with its business spread across the Americas, the Asia Pacific, and Europe holds a Zacks Rank #1 and has a Value Score of A. The company also has an impressive growth rate of 162% for the current year. You can seethe complete list of today’s Zacks #1 Rank stocks here.
Hill-Rom Holdings, Inc. (HRC - Free Report) : This medical technology company works in five core areas – Advancing Mobility, Wound Care and Prevention, Patient Monitoring and Diagnostics, Surgical Safety and Efficiency, and Respiratory Health. The company has an impressive long-term expected growth rate of 13%. The stock has a Value Score of B and a Zacks Rank #2.
AmerisourceBergen Corporation (ABC - Free Report) : AmerisourceBergen is one of the world’s largest pharmaceutical services companies, which focuses on providing drug distribution and related services to reduce health care costs and improve patient outcomes. The stock carries a Zacks Rank #2 and has a Value Score of B. It also has an impressive historical growth rate of 15.5%.
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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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