Benzinga - by Zacks, Benzinga Contributor.
In a market dealing with external shocks, value investing, or the strategy of putting money in underappreciated stocks, is fast gaining popularity. Although these stocks are apparently cheap compared to their peers, investment is made with the hope that the stock price will appreciate reasonably to match the intrinsic value of the business.
Several stocks that have surged significantly in the recent past have shown the overwhelming success of this pure-play investment strategy. Here, we discuss three such stocks — Eldorado Gold (NYSE: EGO), Sasol (NYSE: SSL) and DaVita (NYSE: DVA).
More on Value Investing While searching for a suitable investment option, value investors with varied risk appetite are unlikely to consider price/earnings to growth ratio among a number of other popular metrics like price/earnings (P/E), price/sales (P/S) or price/book value (P/B).
This is because they often find this ratio complicated, considering the limitations in calculating the future earnings growth potential of a stock. Yardsticks such as dividend yield, P/E and P/B are most commonly used to single out stocks trading at a discount.
However, these ratios, while not taking into account the future growth potential of a stock, may end up convincing us to invest in stocks that are at a discount just because of their poor show. This may often lead to "value traps" — a situation when these value picks start to underperform over the long run as 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 to find the intrinsic value of a stock.
There are some drawbacks to using the PEG ratio, though. It doesn't 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 in 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 three stocks that qualified the screening:
Eldorado Gold: The company, together with its subsidiaries, engages in the mining, exploration, development and sale of mineral products primarily in Turkey, Canada, Greece and Romania. By the end of 2024, the company expects to have completed theIntegrated Extractive Waste Management Facility (IEWMF) coffer dam and significantly advanced the IEWMF earthworks, water management facilities, process plant and filter plant.
Eldorado Gold has a long-term expected growth rate of 50.8%. EGO currently carries a Zacks Rank #2 and has a Value Score of A.
Sasol: The company operates as an integrated chemical and energy company in South Africa. Sasol uses selected technologies to safely and sustainably source, produce and market chemical and energy products competitively to create superior value for its customers, shareholders and other stakeholders.
Sasol currently holds a Zacks Rank #1 and has a Value Score of A. SSL also has an impressive five-year expected growth rate of 10.4%.
DaVita: Denver, CO-headquartered DaVita is a leading provider of dialysis services in the United States to patients suffering from chronic kidney failure, also known as end-stage renal disease (ESRD). The company operates kidney dialysis centers and provides related medical services, primarily in dialysis centers and in contracted hospitals across the United States. Its services include outpatient dialysis services, hospital inpatient dialysis services and ancillary services such as ESRD laboratory services and disease management services.
Apart from a discounted PEG and P/E, DaVita currently has a Zacks Rank #2 and a Value Score of A. DVA has a long-term historical growth rate of 15.5%.
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.
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