In a market dealing with external shocks, value investing is fast gaining popularity. The success of value investors like Warren Buffett underscores this. Buffett and his business partner, Charlie Munger, managed to register more than 20% CAGR for Berkshire Hathaway from 1965 through 2022. This compares favorably with a 10% rise of the S&P 500 Index during the same period.
Several other stocks, which have surged significantly in the recent past, have shown the overwhelming success of this pure-play investment strategy. Here, we discuss four such stocks — Arcos Dorados ARCO, Target Corporation TGT, Harmony Gold HMY and Griffon GFF.
More on Value Investing
While searching for a suitable investment option, value investors with a varied risk appetite are unlikely to consider the price/earnings to growth (PEG) ratio among several other popular metrics like price/earnings (P/E), price/sales and price/book value (P/B).
This is because they often find this ratio complicated, considering the limitations in calculating a stock's future earnings growth potential. Yardsticks, such as dividend yield, P/E or P/B, are commonly used to single out stocks trading at a discount.
However, while not taking into account the growth potential of a stock, these ratios might end up convincing us to invest in stocks that are at a discount just because of their poor show. This might 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 find the intrinsic value of a stock.
There are some drawbacks to using the PEG ratio. 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 over 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 the four stocks that qualified the screening:
Arcos Dorados: It is the world’s largest independent McDonald’s franchisee. It operates the largest quick-service restaurant chain in Latin America and the Caribbean. Arcos Dorados has the exclusive right to own, operate and grant franchises of McDonald’s restaurants in 20 Latin American and Caribbean countries and territories with more than 2,300 restaurants.
Arcos Dorados currently sports a Zacks Rank #1 and has a Value Score of A. Arcos Dorados also has an impressive five-year historical growth rate of 12.8%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Target: Minneapolis, MN-based Target provides an array of goods ranging from household essentials and electronics to toys and apparel for men, women and kids. It also houses food and pet supplies, home furnishings and décor, home improvement, automotive products and seasonal merchandise.
Apart from a discounted PEG and P/E, TGT currently has a Zacks Rank #1 and a Value Score of A. Target has a long-term expected growth rate of 14.2%.
Harmony Gold: It is a 1.4-1.5 million ounce specialist gold producer, with a growing copper footprint. It is South Africa’s largest gold producer by volume, with a diversified portfolio of operating assets and projects across South Africa, Papua New Guinea and Australia. These include nine underground mines, two open pit mines and various tailings retreatment operations.
Harmony Gold has an impressive long-term expected growth rate of 22.7%. HMY currently has a Value Score of A and a Zacks Rank of 2.
Griffon: It is a diversified management and holding company that conducts business through wholly-owned subsidiaries. Griffon oversees the operations of its subsidiaries, allocates resources among them and manages their capital structures. Griffon provides direction and assistance to its subsidiaries in connection with acquisition and growth opportunities as well as divestitures.
Apart from a discounted PEG and P/E, GFF currently has a Zacks Rank #1 and a Value Score of A. Griffon has a long-term historical growth rate of 37.2%.
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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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