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Price-to-Earnings (P/E) ratio provides investors with the easiest option to judge whether a company’s stock price actually justifies its current earnings. However, things are not as simple as they seem and considering P/E ratio alone may turn out to be extremely dangerous at times.
The P/E ratio, which does not take into account the future growth potential of a stock, may end up convincing us to buy stocks that are at a discount because of their poor performance and weak fundamentals. This may lead to a “value trap”, a situation where these picks continue to underperform over the long run as the temporary problems, which once pulled down the share price, may persist. In such a case, even if you buy a stock at less than its fair value, you might still end up paying more.
To avoid such value traps, Warren Buffett has advised investors to focus on the earnings growth potential of a stock. And here comes the importance of a not-so-popular value investing metric, the PEG ratio.
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) or 2 (Buy) (whether good market conditions or bad, stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) 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 13 stocks that qualified the screening:
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 currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive growth rate of 177.5% for the next year.
Cosan Limited : Cosan Limited 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 16.3%. The stock currently has a Value Style Score of ‘A’ and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
KB Financial Group Inc. (KB - Free Report) : This financial holding company, providing various banking and related financial services in South Korea and internationally, currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive expected five-year growth rate of 8.4%.
Teradyne, Inc. (TER - Free Report) : This is a leading supplier of automation equipment for test and industrial applications. Teradyne can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score 'B'. Apart from a discounted PEG and P/E, the stock also has an impressive expected growth rate of 14.2% for the next fiscal compared to the industry average of 13.2%.
Western Digital Corporation (WDC - Free Report) : This developer and provider of data storage devices and solutions worldwide currently flaunts a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive growth rate of 15.6% for the next year.
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.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »
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5 Discounted PEG Stocks Ideal for Value Investors
Price-to-Earnings (P/E) ratio provides investors with the easiest option to judge whether a company’s stock price actually justifies its current earnings. However, things are not as simple as they seem and considering P/E ratio alone may turn out to be extremely dangerous at times.
The P/E ratio, which does not take into account the future growth potential of a stock, may end up convincing us to buy stocks that are at a discount because of their poor performance and weak fundamentals. This may lead to a “value trap”, a situation where these picks continue to underperform over the long run as the temporary problems, which once pulled down the share price, may persist. In such a case, even if you buy a stock at less than its fair value, you might still end up paying more.
To avoid such value traps, Warren Buffett has advised investors to focus on the earnings growth potential of a stock. And here comes the importance of a not-so-popular value investing metric, the PEG ratio.
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) or 2 (Buy) (whether good market conditions or bad, stocks with a Zacks Rank #1 (Strong Buy) or #2 (Buy) 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 13 stocks that qualified the screening:
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 currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive growth rate of 177.5% for the next year.
Cosan Limited : Cosan Limited 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 16.3%. The stock currently has a Value Style Score of ‘A’ and carries a Zacks Rank #2. You can see the complete list of today’s Zacks #1 Rank stocks here.
KB Financial Group Inc. (KB - Free Report) : This financial holding company, providing various banking and related financial services in South Korea and internationally, currently holds a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive expected five-year growth rate of 8.4%.
Teradyne, Inc. (TER - Free Report) : This is a leading supplier of automation equipment for test and industrial applications. Teradyne can be an impressive value investment pick with its Zacks Rank #1 and Value Style Score 'B'. Apart from a discounted PEG and P/E, the stock also has an impressive expected growth rate of 14.2% for the next fiscal compared to the industry average of 13.2%.
Western Digital Corporation (WDC - Free Report) : This developer and provider of data storage devices and solutions worldwide currently flaunts a Zacks Rank #1 and has a Value Style score ‘B’. The company also has an impressive growth rate of 15.6% for the next year.
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.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
Click here to sign up for a free trial to the Research Wizard today.
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.
Zacks Restaurant Recommendations: In addition to dining at these special places, you can feast on their stock shares. A Zacks Special Report spotlights 5 recent IPOs to watch plus 2 stocks that offer immediate promise in a booming sector. Download it free »