The investment pattern of the young generation is shifting to hybrid investment from pure play theories like growth or value. According to them, to make a long-term investment more effective, the principles of both value and growth strategies need to be combined.
Consequently, GARP (growth at a reasonable price) investment, often known as a special case of value investment, is gaining popularity. 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 an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps 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 that 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 out of seven stocks that qualified the screening:
MetLife, Inc. (MET - Free Report) is engaged in the insurance, annuities, employee benefits, and asset management businesses. Through its subsidiaries and affiliates, the company is one of the world’s leading financial services companies, providing insurance, annuities, employee benefits and asset management. The stock can be an impressive value investment pick with its Zacks Rank #2 and a Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 12.6%.
Phillips 66 (PSX - Free Report) is a diversified energy manufacturing and logistics company. The 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 also has an impressive expected growth rate of 104.3% for the current year.
United Rentals, Inc. (URI - Free Report) is the largest equipment rental company in the world. The company has an integrated network of 1,198 rental locations in North America and 11 in Europe. The company has an impressive long-term growth rate of 17.8%. 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.
Masco Corporation (MAS - Free Report) designs, manufactures, and distributes home improvement and building products worldwide. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2.
Eldorado Resorts, Inc. (ERI - Free Report) is a gaming and hospitality company. It owns and operates gaming facilities in Ohio, Louisiana, Nevada, Pennsylvania, West Virginia, Colorado, Florida, Iowa, Mississippi, and Missouri. The stock carries a Zacks Rank #2 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.