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 gaining 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 an idea of stocks that are trading at a discount, PEG while adding the growth element to it, helps to 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 stocks that qualified the screening:
Caterpillar Inc. CAT: This company manufactures and sells construction and mining equipment, diesel and natural gas engines, industrial gas turbines, and diesel-electric locomotives for construction, resource, and energy and transportation industries. The stock can be an impressive value investment pick with its Zacks Rank #1 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 15.6%.
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 Score of A. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected growth rate of 16%.
United Rentals, Inc. URI: This is an equipment rental company. It operates in two segments, General Rentals and Trench, Power, and Pump. The company has an impressive long-term growth rate of 17.8%. 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.
DXC Technology Company DXC: This is an independent, end-to-end IT services company, serving nearly 6,000 private and public-sector clients from a diverse array of industries across 70 countries. Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #2.
Perspecta Inc. PRSP: The company provides enterprise information technology (IT) services to government customers in the United States federal, state, and local markets. The stock carries a Zacks Rank #2 and has a Value Score of B.
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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.
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PERSPECTA INC (PRSP) : Free Stock Analysis Report
United Rentals, Inc. (URI) : Free Stock Analysis Report
Caterpillar Inc. (CAT) : Free Stock Analysis Report
Tailored Brands, Inc. (TLRD) : Free Stock Analysis Report
DXC Technology Company. (DXC) : Free Stock Analysis Report
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