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5 Stocks to Buy with Exciting PEG Ratios

There is no denying that a company’s fundamentals are the primary driver of its future performance. If beating the market over the long termis your aim, value investing, which takes into account fundamental strength of companies, is probably the best available option.

For investors believing in this line of thought, there are a number of metrics that can easily single out the stocks trading at a discount. But is this a sufficient condition for success? What if even though the stock is cheap, it has a dearth of catalysts to propel growth?

In such a case, even if you are trying to buy a stock at less than its fair value, you might end up paying more if you misjudge its intrinsic value. To avoid such value traps, Warren Buffet has advised investors to keep a 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 find out a company’s earnings growth potential, just by adding one more parameter to it, the estimated growth rate of a company, PEG becomes an ideal metric to get to 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, a PEG-based investing can be even more rewarding if we consider some other relevant parameters.

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 15 stocks that qualified the screening:

·         Dean Foods Company (DF)

·         BHP Billiton plc (BBL)

·         Trinseo SA (TSE)

·         Manulife Financial Corporation (MFC)

·         LPL Financial Holdings Inc. (LPLA)

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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: http://www.zacks.com/performance.

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TRINSEO SA (TSE): Free Stock Analysis Report
LPL FINL HLDGS (LPLA): Free Stock Analysis Report
DEAN FOODS CO (DF): Free Stock Analysis Report
MANULIFE FINL (MFC): Free Stock Analysis Report
BILLITON ADR (BBL): Free Stock Analysis Report
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