You've likely heard of this valuation method countless times:
The price-to-earnings (P/E ) ratio that analysts use to compare a
stock's current share price to its per-shareearnings .
By this measure, stocks may appear "cheap." Thebenchmark S&P
500 now trades at a P/E of 14 times 2013's estimated earnings --
well below a long-term average of about 15.
But a low P/E doesn't always spell opportunity.
Capital Products Partners (Nasdaq:
Ship Finance International (NYSE:
, both in the oil-shipping industry. These stocks pay
dividends and carry yields between 9 and 12%. Capital Products
trades at 20.8 times 2013's estimated earnings of 37 cents per
unit, while Ship Finance trades at just 9.2 times estimated
earnings of $1.80 a share.
Which is the better deal? You're paying $9.20 for every dollar of
Ship Finance's earnings but $20.80 for every dollar of Capital
Product's earnings. All else equal, Ship Finance appears to give
you more bang for your buck. Right?
It's not that easy. The P/E ratio simply tells you what investors
are willing to pay for a stock's earnings. In fact, investors are
often willing to pay more if these earnings are growing at a faster
rate than other stocks in the same industry. So a company with a
faster expected growth rate may trade at a higher P/E than one with
lower growth expectations.
That's where the P/E and growth (PEG ) ratio comes in handy. It
combines the two measurements in one easy formula. You simply
divide P/E by the earnings growth rate.
For this ratio, the P/Emultiple can be based on next year's
estimated earnings, this year's estimated earnings or trailing
earnings for the past four quarters. I typically use a trailing P/E
since it's based on actual earnings without built-in growth
Generally speaking, stocks are fairly priced when the PEG ratio
equals 1. A PEG of less than 1 is even better, while a PEG of more
than 1 says you may be paying too much for the company's growth.
So let's take another look at Capital Product and Ship
Finance. Analysts expect Ship Finance to grow next year's earnings
at a steady 5.9% pace. In contrast, Capital Product's earnings are
forecast to rocket 85% year over year.
Using the PEG formula, you can see that despite its higher P/E
multiple, Capital Product offers better value. A trailing P/E
of 5.1 divided by a 1-year growth of 85 gives it a PEG of just
0.06. By comparison, Ship Finance carries a PEG of 1.7
PEG is a handy tool, but it short-changesdividend- paying stocks
that may grow more slowly because they pay out their earnings as
dividends to investors. That's where PEGY comes to the rescue.
It provides a more complete measure of value fordividend stocks by
adding the currentdividend yield to the growth rate (You add the
numbers only, without the percentage signs). The P/E is then
divided by the sum of the two.
Ship Finance now looks more tempting with a PEGY of 0.6, once the
9.7%yield is factored into the equation (10/5.9+9.7). But Capital
Product still offers superior value with a PEGY of 0.05, given
an even better yield of 12.1% (5.1/85+12.1).
With this in mind, I combed the income universe for high-yield
bargains with a 1-year PEGY of 1 or below. I identified stocks
yielding at least 5% with an estimated 1-year growth rate of at
least 9% and a P/E of 20 or less.
To avoid companies thatoffer high yields because of a falling share
price, I further refined my search to stocks that had returned at
least 5% year-to-date. After my extensive calculations, here's what
As you can see from the list above, all the stocks I found were
at least yielding 5% and sported a PEGY ratio of less than 1.
Each of these securities merits further research, but if I had to
pick one, my first choice for further analysis would be the
California-based business development company
Hercules Technology Growth Capital (NYSE:
. For more information on business development companies, you can
read my colleague
Risks to Consider:
Of course with investing, nothing is 100% certain. Just because
a dividend stock has a low PEGY, it doesn't necessarilymean it's a
stock worth buying.
Action to Take -->
But when it comes to buying dividend stocks, it's not enough to
just look at the P/E ratio. There are a lot of other factors to
consider, and one of the most important is the stock's PEGY. It's a
good indicator of what you're paying for the company's earnings
with respect to growth, and the stock's dividend yield.
-- Carla Pasternak
Carla Pasternak does not personally hold positions in any
securities mentioned in this article. StreetAuthority LLC does not
hold positions in any securities mentioned in this article.
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