GARP (growth at a reasonable price) investment, often known as a special case of value investment, is gaining popularity among the new generation of investors. According to them, to make a long-term investment more effective, the principles of both value and growth strategies need to be combined.
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 an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps to identify stocks that have solid 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 out of the seven stocks that qualified the screening:
Gilead Sciences, Inc. GILD: This biopharmaceutical company is focused on developing drugs for the treatment of human immunodeficiency virus (HIV), liver diseases, hematology/oncology diseases and inflammation/respiratory diseases. 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 12.4%.
Jazz Pharmaceuticals plc JAZZ: This is a specialty biopharmaceutical company focusing on areas of sleep and hematology/oncology. The stock can also 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 historical growth rate of 15.9%.
Amdocs Limited DOX is one of the leading providers of customer care, billing and order management systems for communications and Internet services.The company has an impressive long-term growth rate of 8.5%. The stock currently has a Value Score of A and a Zacks Rank #2. You can see the complete list of today's Zacks #1 Rank stocks here.
Arch Capital Group Ltd. ACGL: This property and casualty (P&C) insurer offers insurance, reinsurance and mortgage insurance across the world. Through its wholly owned subsidiaries, it provides a wide range of products and services including primary and excess casualty coverages, professional indemnity, workers compensation and umbrella liability and employers’ liability insurance coverages to name a few. Apart from a discounted PEG and P/E, the stock has a Value Score of B and holds a Zacks Rank #2.
Legg Mason, Inc. LM: This is a global asset management firm focused on the growth and preservation of its clients' capital through its proprietary mutual funds and separately-managed accounts (SMAs). The stock carries a Zacks Rank #2 and has a Value Score of A.
You can get the rest of the stocks on this list by signing up now for your 2-week free trial to the Research Wizard and start using this screen in your own trading. Further, you can also create your own strategies and test them first before taking the investment plunge.
The Research Wizard is a great place to begin. It's easy to use. Everything is in plain language. And it's very intuitive. Start your Research Wizard trial today. And the next time you read an economic report, open up the Research Wizard, plug your finds in, and see what gems come out.
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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Amdocs Limited (DOX): Free Stock Analysis Report
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Gilead Sciences, Inc. (GILD): Free Stock Analysis Report
Jazz Pharmaceuticals PLC (JAZZ): Free Stock Analysis Report
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