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 say, 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 Buffett, 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 their earnings growth potential.
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 — Molson Coors Beverage TAP, BioMarin Pharma BMRN, Devon Energy DVN and Jazz Pharmaceuticals JAZZ.
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.
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 13 stocks that qualified the screening:
Molson Coors: This global manufacturer and seller of beer and other beverage products has an impressive diverse portfolio of owned and partner brands. Molson Coors crafts high-quality, innovative products with an aim of delighting the world's beer drinkers, thus targeting to become the first choice for its consumers.
TAP currently sports a Zacks Rank #1 and has a Value Score of A. Molson Coors also has an impressive five-year expected growth rate of 6.3%.
BioMarin: San Rafael, CA-based BioMarin focuses on the development and commercialization of treatments for life-threatening severe medical conditions, mainly for children. The company's portfolio comprises eight marketed products, namely, Aldurazyme, Naglazyme, Kuvan, Vimizim, Brineura, Palynziq, Voxzogo and Roctavian.
Apart from a discounted PEG and P/E, BMRN currently has a Zacks Rank #2 and a Value Score of B. BioMarin has a long-term historical growth rate of 77.6%.
Devon Energy: This independent energy company is engaged primarily in the exploration, development and production of oil and natural gas. Devon Energy’s oil and gas operations are mainly concentrated in the onshore areas of North America, primarily in the United States.
DVN carries a Zacks Rank #2 and has a Value Score of A. Devon Energy also has an impressive five-year historical growth rate of 40.1%.
Jazz: Dublin, Ireland-based Jazz Pharmaceuticals is a specialty biopharmaceutical company with a focus on neuroscience and oncology. The company derives most of its revenues from its sleep disorder drugs — Xywav and Xyrem. Jazz recently received approval for Rylaze in Europe and a new cancer drug Ziihera, which should boost oncology drug sales.
JAZZ has an impressive long-term expected earnings growth rate of 7.4%. It currently has a Value Score of A and sports a Zacks Rank of 1. You can see the complete list of today’s Zacks #1 Rank stocks here.
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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.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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Devon Energy Corporation (DVN) : Free Stock Analysis Report
BioMarin Pharmaceutical Inc. (BMRN) : Free Stock Analysis Report
Molson Coors Beverage Company (TAP) : Free Stock Analysis Report
Jazz Pharmaceuticals PLC (JAZZ) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
Zacks Investment Research
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