The popularity of value investing is growing by leaps and bounds. It is one of the favorite investing mantras of billionaire investors. As per data provided by a recent Forbes article, shares of value investment guru Warren Buffett’s conglomerate Berkshire Hathaway increased 20% in 2016, boosting his personal fortune by $12.3 billion (more than any other billionaire in the U.S.) to $74.2 billion.
Warren Buffett believes that proper understanding of the “intrinsic value” of a stock may ease out many problems with regard to value investment. According to him, going by the fundamentals of value investing, while picking undervalued stocks, we also need to focus on their earnings growth potential.
While yardsticks such as dividend yield, the ratio of price to earnings, to sales or to book value are the most common value investing matrices that can easily single out stocks trading at a discount, these ratios fail to consider the future potential of a stock. PEG is the ratio with the earnings growth component in it.
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 finding 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 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 of the 27 stocks that qualified the screening:
Teck Resources Limited TECK : 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 #2 and has a Value Style score of ‘A’. The company also has an impressive growth rate of 177.5% for the next year.
Teradyne, Inc. TER: The company 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 13.7% for the next fiscal.
Western Digital Corporation WDC: This developer and provider of data storage devices and solutions worldwide currently flaunts a Zacks Rank #1 and has a Value Style Score of ‘B’. The company also has an impressive growth rate of 38.1% for the current year.
ArcelorMittal MT: Based in Luxembourg, ArcelorMittal is the world’s leading steel and mining company. With a presence in more than 60 countries, it operates a balanced portfolio of cost competitive steel plants across both the developed and developing world. It is the leader in all the main sectors – automotive, household appliances, packaging and construction. With a Zacks Rank #1 and a Value Style Score of ‘B’, this stock can prove to be a solid value investment pick at present. The stock has an impressive expected growth rate of 52.1% for the current fiscal.
NextEra Energy Partners, LP NEP: This Florida-based growth-oriented limited partnership formed by NextEra Energy to acquire, manage and own contracted clean energy projects with stable, long-term cash flows. The company owns interests in wind and solar projects in North America, as well as natural gas infrastructure assets in Texas. Apart from a discounted PEG and P/E, the stock also holds a Zacks Rank #2 along with a Value Style Score of ‘A’.
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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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