Going by the Oracle of Omaha’s success story, value investment is one of the most tempting strategies to bet on even amid uncertain market conditions. Per data provided by a Forbes article, shares of Berkshire Hathaway, owned by Warren Buffett, increased 20% in 2016, boosting the Oracle of Omaha’s personal fortune by $12.3 billion (more than any other billionaire in the U.S.) to $74.2 billion.
While searching for a suitable value investment option, investors are unlikely to consider price/earnings to growth (PEG) ratio among a number of other popular value metrics like price/earnings (P/E), price/sales (P/S) or price/book value (P/B). This is because they often find this ratio complicated, considering the limitations in calculating the future earnings growth potential of a stock.
However, at a time when volatility strikes every second day, it is pointless to ponder on methods, which do not consider a stock’s future growth rate while calculating its intrinsic merit. Yardsticks such as dividend yield, P/E or P/B are most commonly used to single out stocks trading at a discount.
However, these ratios, while not taking into account the future growth potential of a stock, may end up convincing us to invest in stocks that are at a discount just because of their poor show. This may often lead to “value traps” — a situation when these value picks start to underperform over the long run as the temporary problems, which once drove the share price down, turn out to be persistent.
In such a case, even if you buy a stock at less than its fair value, you might still end up paying more. And here comes the importance of this not-so-popular but crucial value investing metric, the PEG ratio.
The PEG ratio is defined as (Price/ Earnings)/Earnings Growth Rate
A low 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.
There are some drawbacks to using the PEG ratio though. It does not 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 some of 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 six stocks that qualified the screening:
Molina Healthcare, Inc. (MOH): Headquartered in Long Beach, CA, Molina Healthcare is a multi-state managed care organization, participating exclusively in government-sponsored healthcare programs such as Medicaid and State Children's Health Insurance Program (SCHIP) catering to low-income persons. The company has an impressive long-term historical growth rate of 58.1%. The stock currently has a Value Score of A and a Zacks Rank #1. You can see the complete list of today's Zacks #1 Rank stocks here.
AngloGold Ashanti Limited (AU - Free Report) : This is a gold mining company. It also produces silver, uranium, and sulphuric acid; and dore bars. The stock currently sports a Zacks Rank #1 and has a Value Score of A. The company also has an impressive long-term expected growth rate of 19.4%.
AmerisourceBergen Corporation (ABC - Free Report) : It 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. Apart from a discounted PEG and P/E, the stock has a Zacks Rank #2 and a Value Score of A.
Tetra Tech, Inc. (TTEK - Free Report) : This is a leading provider of consulting, construction management, engineering, program management and technical services. It serves clients by providing cost-effective and innovative solutions on dealing with fundamental needs for water, environmental and alternative energy services. The company currently holds a Zacks Rank #2 and has a Value Score of A. The company also has an impressive expected five-year growth rate of 15%.
Wesco Aircraft Holdings, Inc. (WAIR - Free Report) : This is an independent distributor and provider of comprehensive supply chain management services to the global aerospace industry. The company holds a Zacks Rank #2 and has a Value Score of A. The stock also has an impressive earnings growth rate of 12% for the next five years.
The GEO Group, Inc. : This is the first fully integrated equity real estate investment trust specializing in design, financing, development, and operation of correctional, detention, and community reentry facilities around the globe. The company currently holds a Zacks Rank #1 and has a Value Score of A. The company also has an impressive expected five-year growth rate of 6%.
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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.