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, may end up convincing us to invest in stocks that are at a discount just because of their poor show. This may 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 to 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 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 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 of the 20 stocks that qualified the screening:
Oracle Corporation ORCL : It is one of the largest enterprise-grade database, middleware and application software providers. Oracle has expanded its cloud computing operations over the last couple of years. The company offers cloud solutions and services that can be used to build and manage various cloud deployment models. The company has an impressive long-term expected growth rate of 9.8%. The stock carries a Zacks Rank #2 and has a Value Score of B. You can see the complete list of today's Zacks #1 Rank stocks here .
AngloGold Ashanti Limited AU : It operates as a gold mining company. It also produces silver, uranium and sulphuric acid and dóre bars. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2. The company also has an impressive long-term expected growth rate of 33%.
AmerisourceBergen Corporation ABC : It is one of the world's largest pharmaceutical services companies, which focuses on providing drug distribution and related services to reduce health care costs and improve patient outcomes. Apart from a discounted PEG and P/E, the stock holds a Zacks Rank #2 and has a Value Score of A.
Ford Motor Company F : This is an automotive, financial services and mobility company with operations in the United States and across the world. The company currently holds a Zacks Rank #1 and has a Value Score of A. The company also has an impressive expected five-year growth rate of 7.3%.
CACI International Inc CACI : Based in Arlington, VA, CACI International delivers IT applications and infrastructure to improve communications and secure the integrity of information systems and networks, enhance data collection and analysis, and increase efficiency and mission effectiveness. The company holds a Zacks Rank #2 and has a Value Score of A. The stock also has an impressive earnings growth rate of 10% for the next five years.
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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 .
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report Ford Motor Company (F): Free Stock Analysis Report CACI International, Inc. (CACI): Free Stock Analysis Report Oracle Corporation (ORCL): Free Stock Analysis Report AngloGold Ashanti Limited (AU): Free Stock Analysis Report AmerisourceBergen Corporation (ABC): Free Stock Analysis Report To read this article on Zacks.com click here. Zacks Investment Research