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 favorably compares 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 five such stocks — Alibaba Group BABA, Encompass Health EHC, Molson Coors Beverage TAP, Ford Motor F and Albemarle Corporation ALB.
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While searching for a suitable investment option, value investors with a varied risk appetite are unlikely to consider 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 five out of the 27 stocks that qualified the screening:
Alibaba: It is one of the leading e-commerce giants in China. Over the last few years, the company has transformed itself from being a traditional e-commerce company to a conglomerate that has businesses ranging from logistics and food delivery to cloud computing.Alibaba Group is currently represented by three businesses — Alibaba.com, Taobao and Tmall.
Alibaba currently holds a Zacks Rank #2 and has a Value Score of A. Alibaba also has an impressive five-year expected growth rate of 19.9%.
Encompass Health: It is a provider of integrated healthcare services. It offers facility-based patient care through its network of inpatient rehabilitation hospitals. With a national footprint that includes 158 hospitals across 36 states and Puerto Rico, the company delivers high-quality, cost-effective, integrated care in the healthcare space.
Apart from a discounted PEG and P/E, Encompass Health currently has a Zacks Rank #2 and a Value Score of A. Encompass Health has a long-term expected growth rate of 11.8%.
Molson Coors: It is a global manufacturer and seller of beer and other beverage products. It has an impressive and diverse portfolio of owned and partner brands. These include global priority brands such as Blue Moon, Miller Lite, CoorsBanquet, Coors Light, Miller Genuine Draft and Staropramen as well as regional champion brands like Carling, Molson Canadian. The company also boasts some other major country-specific brands, along with craft and specialty beers, namely, Creemore Springs, Henry’s Hard, Cobra, Doom Bar and Leinenkugel’s.
Molson Coors has an impressive long-term expected growth rate of 7.3%. Molson Coors stock currently has a Value Score of B and a Zacks Rank of 1.
Ford Motor: Dearborn, MI-based Ford is one of the leading automakers in the world. It manufactures, markets and services cars, trucks, sport utility vehicles, electrified vehicles, and Lincoln luxury vehicles. Ford’s reportable operating segments are Ford Blue, Ford Model E, Ford Pro, Ford Next and Ford Credit.
Apart from a discounted PEG and P/E, Ford Motor currently has a Zacks Rank #2 and a Value Score of A. Ford Motor has a long-term expected growth rate of 7%.
Albemarle: Charlotte, NC-based Albemarle is a premier specialty chemicals company with leading positions in attractive end markets globally. It is a leading producer of highly-engineered specialty chemicals geared to meet customer requirements across a bevy of end markets, including petroleum refining, consumer electronics, energy storage, construction and automotive.
Albemarle has a long-term expected growth rate of 12.6%. Albemarle currently carries a Zacks Rank of 2 and has a Value Score of A.
This article originally appeared on Zacks
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