With the market getting increasingly fickle on external shocks, investors are more focused on finding an investment strategy that emphasizes judging a stock's inherent potential. Needless to mention, value investment is gaining popularity day by day. However, this apparently simple-to-understand investing strategy has historically shown dangerous outcomes a number of times because of people’s oversight of its basics.
Warren Buffet, the popular value investor, believes that proper understanding of the “intrinsic value” of a stock may ease out many problems in this respect. According to him, going by the fundamentals of value investing, as we pick stocks which the market is currently undervaluing, we also need to focus on the earnings growth potential of a stock.
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 — The Gap Inc. GAP, Embecta Corp. EMBC, Blue Bird BLBD and ZIM Integrated Shipping Services ZIM.
However, this simple value investment technique has some drawbacks, and not properly understanding the strategy may often lead to “value traps.” In such a situation, these value picks start to underperform over the long run when 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 will 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 the importance of a not-so-popular value investing metric, the PEG ratio, lies.
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 does not consider the 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 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 four of the seven stocks that qualified the screening:
Gap: With more than 3,600 stores worldwide, Gap is a premier international specialty retailer offering a diverse range of clothing, accessories, and personal care products. It offers products for men, women, and children under the Old Navy, Gap, Banana Republic, Athleta, Intermix, and Hill City brands.
Gap currently sports a Zacks Rank #1 and has a Value Score of A. GAP also has an impressive five-year expected growth rate of 11.1%.
embecta: Embecta Corp. or embecta is a medical device company that focuses on the provision of various solutions to enhance the health and wellbeing of people living with diabetes. Its products include pen needles, syringes and safety injection devices, as well as digital applications to assist people with managing patient's diabetes.
Apart from a discounted PEG and P/E, PFE currently has a Zacks Rank #1 and a Value Score of A. EMBC has a long-term expected growth rate of 6.5%.
Blue Bird: Together with its subsidiaries, the company designs, engineers, manufactures, and sells school buses in the United States, Canada and internationally. The company operates through two segments, Bus and Parts.
BLBD sports a Zacks Rank #1 and has a Value Score of A. Blue Bird also has an impressive five-year historical growth rate of 20%.
ZIM: It is a global container liner shipping company. The company along with its subsidiaries, provides container shipping and related services in Israel and internationally. The company provides customers with innovative seaborne transportation and logistics services.
ZIM has an impressive long-term expected earnings growth rate of 26.2%. It currently has a Value Score of A and flaunts a Zacks Rank of 1. You can see the complete list of today’s Zacks #1 Rank stocks here.
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.
Click here to sign up for a free trial to the Research Wizard today.
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.
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
Want the latest recommendations from Zacks Investment Research? Today, you can download 7 Best Stocks for the Next 30 Days. Click to get this free report
The Gap, Inc. (GAP) : Free Stock Analysis Report
Blue Bird Corporation (BLBD) : Free Stock Analysis Report
ZIM Integrated Shipping Services Ltd. (ZIM) : Free Stock Analysis Report
Embecta Corp. (EMBC) : Free Stock Analysis Report
To read this article on Zacks.com click here.
Zacks Investment Research
Disclaimer: Investing carries risk. This is not financial advice. The above content should not be regarded as an offer, recommendation, or solicitation on acquiring or disposing of any financial products, any associated discussions, comments, or posts by author or other users should not be considered as such either. It is solely for general information purpose only, which does not consider your own investment objectives, financial situations or needs. TTM assumes no responsibility or warranty for the accuracy and completeness of the information, investors should do their own research and may seek professional advice before investing.