Investors seeking long-term growth often wonder whether they should resort to any of the fundamental strategies like growth or value, or follow an approach that combines the best of both. Going by Warren Buffett, these two approaches are joined at the hip. In other words, to make a long-term investment more effective, the principles of both value and growth strategies need to be combined.
It has been observed that strategic mingling of both growth and value investing principles gives us a mixed investing strategy. Termed as GARP (growth at a reasonable price), this approach 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 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 a 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.
Here are five stocks that qualified the screening:
AutoZone, Inc. (AZO - Free Report) : This is one of the nation’s leading specialty retailers of automotive replacement parts and accessories, operating in the Do-It-Yourself retail, Do-It-for-Me auto parts and products markets. Apart from a Zacks Rank #2, the company also has an impressive historical five-year growth rate of 12.8%.
Stamps.com Inc. (STMP - Free Report) : The company provides Internet-based mailing and shipping solutions to mail and ship various mail pieces and packages through the United States Postal Service (USPS) under the Stamps.com and Endicia brands. Its solutions support various USPS mail classes, including First Class Mail, Priority Mail, Priority Mail Express, Media Mail, Parcel Select, and others. The company has an impressive long-term historical growth rate of 39.6%. The stock currently has a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
Tech Data Corporation (TECD - Free Report) : Based in Clearwater, FL., Tech Data is one of the leading wholesale distributors of information technology (IT) products, logistics management and other value-added services. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #1.
Exelixis, Inc. (EXEL - Free Report) : San Francisco, CA-based Exelixis is a biopharmaceutical company focused on developing and commercializing small-molecule therapies for the treatment of cancer. The stock currently carries a Zacks Rank #2. The company also has an impressive current-year growth rate of 154.9%.
Regeneron Pharmaceuticals, Inc. (REGN - Free Report) : Tarrytown, NY-based Regeneron is a biopharmaceutical company focused on the discovery, development and commercialization of treatments targeting serious medical conditions. The company’s portfolio boasts marketed drugs like Eylea (for several eye diseases) and Praluent (heterozygous familial hypercholesterolemia). The stock currently carries a Zacks Rank #2. It also has an impressive long-term historical earnings growth rate of 34.6% for the next year.
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