In a market hurt by external shocks, value investing is fast gaining popularity. The success of value investors like Warren Buffett further underscores this. Buffett and his business partner, Charlie Munger managed to register 20% compound annual growth in the market value of Berkshire Hathaway from 1965 through 2020 compared with 10.2% rise of the S&P 500 during the same period.
However, while searching for a suitable investment option, value investors with varied risk appetite are unlikely to consider price/earnings to growth (PEG) ratio among a number of other popular 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. 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, might end up convincing us to invest in stocks that are at a discount just because of their poor show. This might often lead to “value traps” — a situation when these value picks start to underperform over the long run as the temporary problems, which once pulled down the share price, 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 find the intrinsic value 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 over 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 five out of the 20 stocks that qualified the screening:
Olin Corporation
OLN
: Based in Clayton, MO, Olin Corporation is a vertically-integrated global producer and distributor of chemical products and U.S. maker of ammunition. Internationally, the company operates in regions including Latin America, Asia Pacific and Europe. Olin’s operations are focused in three business segments — Chlor Alkali Products and Vinyls, Epoxy and Winchester. Olin has a long-term expected growth rate of 52.6%. The stock currently carries a Zacks Rank of 1 and has a Value Score of A. You can see
the complete list of today’s Zacks #1 Rank stocks here
.
Quest Diagnostics Incorporated
DGX
: Headquartered in Madison, NJ, this is one of the largest providers of commercial laboratory services in North America. The company provides lab testing services primarily to physicians, hospitals, managed care organizations, employers, government institutions, and other independent clinical laboratories. The company currently holds a Zacks Rank #2 and has a Value Score of A. It also has an impressive five-year expected growth rate of 26.5%.
Equinor ASA
EQNR
: Headquartered in Stavanger, Norway, Equinor ASA is one of the premier integrated energy companies in the world, with operations spreading across 30 countries. In Europe, the company is the second-largest supplier of natural gas. Equinor is also a leading seller of crude oil. Apart from a discounted PEG and P/E, the stock currently sports a Zacks Rank #1 and has a Value Score of A. Equinor has a long-term expected growth rate of 50.8%.
Teck Resources Ltd
TECK
: Vancouver, Canada-based Teck Resources Limited is a diversified resource company committed to mining and mineral development with business units focused on steelmaking coal, copper, zinc and energy. The company’s principal products include steelmaking coal; copper concentrates and refined copper cathodes; refined zinc and zinc concentrates; energy products, such as bitumen; and lead concentrates. It has an impressive long-term expected growth rate of 32.8%. The stock currently has a Value Score of B and carries a Zacks Rank of 1.
The Goldman Sachs Group, Inc.
GS
: This is a leading global financial holding company providing investment banking, securities, investment management and consumer banking services to a diversified client base. The company is headquartered in New York, with offices in London, Frankfurt, Tokyo, Hong Kong and other major financial centers globally. The company currently holds a Zacks Rank #2 and has a Value Score of B. It also has an impressive five-year historical growth rate of 14.4%.
Get the rest of the stocks on the list and start putting this and other ideas to the test. It can all be done with the Research Wizard stock picking and backtesting software.
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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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