The investment pattern of the millennials is gradually tending toward hybrid investment from pure play theories like growth or value. According to them, to make a long-term investment more effective, the principles of both value and growth strategies need to be combined.
GARP (growth at a reasonable price) investment, often known as a special case of value investment, is finding prominence among new generation stakeholders. What GARPers look for is whether the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
And here lies the importance of a not-so-popular fundamental metric, the price/earnings growth (PEG) ratio. Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.
The PEG ratio is defined as: (Price/ Earnings)/Earnings Growth Rate
It relates the stocks P/E ratio with future earnings growth rate.
While P/E alone only gives the idea of stocks, which are trading at a discount, PEG while adding the growth element to it, helps to find those stocks that have solid future potential.
A lower PEG ratio, preferably less than 1, is always better for GARP investors.
Say for example, if a stock's P/E ratio is 10 and expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio that indicates both undervaluation and future growth potential.
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 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 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 16 stocks that qualified the screening:
The Timken CompanyTKR : This company develops and markets bearings, transmissions, gearboxes, belts, chains, lubrication systems, couplings, industrial clutches and brakes, and related products worldwide. It operates through two segments, Mobile Industries and Process Industries. The stock can be an impressive value investment pick with its Zacks Rank #2 and Value Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 11.6%.
Tailored Brands, Inc.TLRD : This is a men's specialty apparel retailer in the United States and Canada. Its brands include Men's Wearhouse, Jos. A. Bank, Joseph Abboud, Moores Clothing for Men and K&G Fashion Superstores. The stock can also be an impressive value investment pick with its Zacks Rank #2 and Value Style Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 16.5%.
Dollar General CorporationDG : This discount retailer offers products that are frequently used and replenished, such as food, snacks, health and beauty aids, cleaning supplies, basic apparel, housewares and seasonal items at everyday low prices in convenient neighborhood locations. The company has an impressive long-term growth rate of 14.6%. The stock currently has a Value Score of B and a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here.
Leucadia National CorporationLUK : This is a diversified holding company that focuses on financial service businesses and investments in the Americas, Europe, and Asia. Its services include equities research, sales, and trading; financing, securities lending, and other brokerage; wealth management; fixed income sales and trading; futures; equity capital markets, debt capital markets, and financial advisory; and asset management services. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #2.
SMART Global Holdings, Inc.SGH : The company designs, manufactures, and supplies specialty memory solutions worldwide. The stock carries a Zacks Rank #1 and has a Value Score of B. It also has an impressive long-term expected earnings growth rate of 15%.
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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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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 reportLeucadia National Corporation (LUK): Free Stock Analysis ReportTimken Company (The) (TKR): Free Stock Analysis ReportDollar General Corporation (DG): Free Stock Analysis ReportTailored Brands, Inc. (TLRD): Free Stock Analysis ReportSMART Global Holdings, Inc. (SGH): Free Stock Analysis ReportTo read this article on Zacks.com click here.