Looking for growth and value is a winning combination.
Especially now, with concerns over slowing growth and rich valuations.
And while there are still plenty of companies out there with great growth rates and attractive valuations, it's getting harder to find stocks that fit squarely into both categories.
First off, Growth Investors focus on companies with great earnings growth. And this makes sense since earnings drive prices. But nobody wants to overpay for good growth.
Value Investors focus on low valuation metrics, like low P/Es for example. But many companies have low P/Es because they don't have any real growth to speak of. They lack earnings power. And people aren't willing to pay up for these stocks because there’s nothing to pay up for.
But looking for both growth and value is a great combination and helps alleviate the pitfalls of having one but not the other.
But I believe there's a right way and wrong way to find both growth and value stocks.
What I mean is this:
Most will start off with either one or the other. Like looking for stocks with the biggest growth rates first, and then narrowing those stocks down to the ones with the smallest P/E ratios.
But if the biggest growth rate stocks all had high P/E ratios (let's say in excess of 20 or more, for example) are you really finding the best of the value stocks? The answer is no. You're only finding the growth stocks with the lowest valuations – even though they may be quite high.
Likewise, if you first screened for the lowest P/E ratios, and then narrowed that list down to the ones with the biggest growth rates – if the lowest P/E stocks all had sub-par growth rates - you'd only be selecting the best of the sub-par growth stocks and not really getting both the growth and value you were looking for.
Some try to overcome this by plugging in classical metrics like P/E under 20 and growth rates over 20. But you'll have a ton of stocks filling up that list and you'll be digging thru a ton of average stocks, not the best of each category.
So how does one find these stocks the right way?
I do it by using a uniform ranking on both categories.
And that's the focus of this week's screen.
It focuses on companies with the highest growth rates AND the lowest P/E ratios ALL AT THE SAME TIME.
Let me explain.
The screen starts off by looking at:
- Companies with one year Projected Growth Rates in the top 20 percentile of all companies.
(Using a Uniform Rank of 1-99 (99 being the best growth rates), I screened for stocks ranked 80 or better, meaning better than 80% of all the other companies out their in terms of growth rates.)
- Companies that also happened to have the lowest forward (F1) P/Es – lower than 80% of all other companies.
(Again, using a Uniform Rank of 1-99 (this time 99 having the lowest P/Es), I screened for stocks ranked 80 or better, meaning companies with P/Es lower that 80% of all the other companies out there.)
- They all have to have a Zacks Rank of 2 or less.
(Meaning no 'Holds', 'Sells' or 'Strong Sells' allowed.)
- And this was all applied to stocks trading at or above $5, with average daily trading volumes of 100,000 shares or more.
So with this screen, we're not starting with one and then looking for the other. The order of the above parameters is irrelevant. If I switched it around, I'd get the same stocks.
Because essentially I'm demanding that the companies have to have BOTH growth rates AND valuations in the 80th percentile, i.e., better than 80% of all the other stocks out there. And better on each category.
By the way, for those trying to do this on their own at home, here's what the screen looks like. The uniform ranking was done in the calculation expression feature in the Research Wizard.
This screen also comes pre-loaded with the Research Wizard and it's called sow_growth and value.
Below are 5 stocks that made it thru this week's screen:
Each one of these stocks (and all of the stocks on the entire list), have market-beating growth rates with below market P/E values. A great combination.
Check it out for yourself and get the rest of the stocks on this list. See where your stocks Rank out of all of the other stocks out there, and test your own strategies and see how they've done. Find out what works and what doesn't. It can all be done with the Research Wizard stock picking and backtesting program.
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: http://www.zacks.com/performance.
More From Zacks.com