At a time when volatility strikes every second day, investors often rely on value investing rather than other options like growth or momentum. As soon as other investors start selling their stocks at a cheaper rate in times of market uncertainty, value investors take this as an opportunity to pick good stocks at a discounted price.
Several stocks that have surged significantly in the recent past have shown the overwhelming success of this pure-play investment strategy. Here, we discuss four such stocks — Dow Inc. DOW, Hewlett Packard HPE, StoneCo STNE and Intercorp Financial Services IFS.
However, this apparently simple value investment technique has some drawbacks and not understanding the strategy properly may often lead to “value traps.” In such a situation, these value picks start to underperform over the long run as the temporary problems, which once drove the share price down, turn out to be persistent.
There are many value investment yardsticks, such as dividend yield, P/E or P/B, which are simple and can single out whether a stock is trading at a discount.
However, for investors looking to escape such value traps, it is also vital to determine where the stock would be headed in the next 12 to 24 months. Warren Buffett advises these investors to focus on the earnings growth potential of a stock. This is where lies the importance of a not-so-popular value investing metric, the PEG ratio.
PEG Ratio at a Glance
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 purposes)
Zacks Rank #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.
Our PEG-Driven Picks
Here are four stocks that qualified the screening:
Dow: This is a material science company, providing a world-class portfolio of advanced, sustainable and leading-edge products. Dow offers a vast range of differentiated products and solutions across high-growth market segments such as packaging, infrastructure and consumer care. Its ethylene plant in Freeport, TX, having a total capacity of 2,000 kilotons per year, is the largest ethylene cracker on the planet.
DOW currently has a Zacks Rank #1 and a Value Score of B. Dow also has an impressive five-year expected growth rate of 56%. You can see the complete list of today’s Zacks #1 Rank stocks here.
Hewlett Packard: Headquartered in Spring, TX, Hewlett Packard Enterprise Company reports financial results under five segments: Server, Hybrid Cloud, Networking, Financial Services and Corporate Investments and Other. At present, HPE is executing well on its mix shift toward higher-value networking, cloud and AI, supported by the completed Juniper acquisition, integration running ahead of plan and Catalyst cost synergies.
Hewlett Packard currently has a Zacks Rank #1 and a Value Score of B. HPE also has an impressive five-year expected growth rate of 32%.
StoneCo: The company provides financial technology and software solutions for merchants and partners across Brazil. Its offerings include electronic payments, digital banking, credit, Pix transactions, subscription billing and Tap to Phone solutions for in-store, online and mobile commerce.
Apart from a discounted PEG and P/E, StoneCo currently has a Zacks Rank #2 and a Value Score of A. STNE has a long-term expected growth rate of 23.6%.
Intercorp: The company provides banking, insurance, wealth management and payment solutions for retail and commercial clients in Peru. Intercorp’s services include loans, deposits, insurance, investment management, card processing, digital payments and electronic commerce infrastructure.
Intercorp has a Zacks Rank #1 and a Value Score of B. IFS also has an impressive five-year expected growth rate of 12.1%.
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Dow Inc. (DOW): Free Stock Analysis Report
Hewlett Packard Enterprise Company (HPE): Free Stock Analysis Report
StoneCo Ltd. (STNE): Free Stock Analysis Report
Intercorp Financial Services Inc. (IFS): Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).