5 Excellent Value Stocks Based On Low PEG Ratio

The popularity of value investing is on the rise. The success of billionaire value investors like Warren Buffett further underscores the fact. Per a July Motley Fool article, over the past 50 years, his conglomerate Berkshire Hathaway’s stock has yielded a compound annual return of 20.8%. This indicates that an investment of $10,000 in 1965 would be worth $88 million today.

Buffett believes that proper understanding of the “intrinsic value” of a stock may ease out many problems with regard to value investment. According to him, going by the fundamentals of value investing while picking undervalued stocks, investors need to focus on their earnings growth potential.

While yardsticks such as dividend yield, the ratio of price to earnings, sales or book value are the most common value investing matrices that can easily single out stocks trading at a discount, these ratios fail to consider the potential of a stock. PEG is the ratio with the earnings growth component in it.

The PEG ratio is defined as: (Price/Earnings)/ Earnings Growth Rate

A lower 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.

Unfortunately, this ratio is often neglected due to investors’ limitation to calculate the future earnings growth rate of a stock.

There are some drawbacks to using the PEG ratio though. It doesn’t consider the very common situation of changing growth rates such as the forecast of the first three years at very high growth followed by a sustainable but lower growth rate in the long term.

Hence, PEG-based investing can turn out to be even more rewarding if some other relevant parameters are taken into consideration.

Here are 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.)