HCPLive Network
PERSONAL FINANCE

The Most Explosive Combination in Investing

Tracey Ryniec | Sunday, July 21, 2013
This article was originally published by Zacks.com.
 
Come rain or shine, I'm a value investor. I love the thrill of buying a stock that the rest of the market is ignoring.
 
Every once in a while, though, I sneak a peek at companies with double digit earnings growth, hear the siren call of growth, and try to justify the valuation in order to buy the stock.
 
But what if you could invest in a company that had growth and was also undervalued?
 
I know what you're thinking — it's nearly impossible to find those stocks. It's the most explosive combination in investing: a value stock that also has growth.
 
But here's a little secret.
 
Those stocks do exist.
 
How do you find them?

The secret to finding both value and growth
Value investors have long looked to the price-to-earnings (P/E) ratio as a screen for value stocks. A low P/E ratio is believed to mean that a company is undervalued.
 
However, Benjamin Graham, considered to be the "father" of value investing, found that a low P/E ratio wasn't enough to unearth the true undervalued companies. He looked to the PEG ratio instead, which combined both value and growth — a more potent combination.
 
The PEG ratio is calculated by taking the P/E ratio and dividing it by the five-year projected growth rate.
 
Confused yet?
 
These days you don't really need to figure it out yourself as most financial web sites, including Zacks.com, provide the PEG ratio for you as screening criteria when looking for stocks.
 
What's a good PEG ratio?
A company that is considered fairly valued will have a P/E ratio that equals its growth rate. So the PEG will equal 1.0.
 
A more expensive stock will be above 1.0.
 
Normally, a stock with a PEG ratio under 1.0 is considered "undervalued" as that means the market is underestimating the earnings and/or it is also growing faster than expected.
 
So, that's what you should be looking for when you see the PEG ratio. You want a ratio under 1.0.

How the PEG ratio really works
1) You could have a company with a P/E ratio of 30 and a projected growth rate of 15%. This company clearly doesn't look like it's undervalued with a P/E ratio that high. You would be right. Plugging it into the formula, you get 30/15 = PEG of 2.0. Since 2.0 is above 1.0, it is considered an expensive stock.
 
2) Let's say you have a company with a P/E ratio of 40 and a projected growth rate of 50%. With a P/E of 40, it clearly would not seem to be a good value, but plugging it into the formula gives you a PEG ratio of 0.8 (40/50= 0.8). Since that is under 1.0, it is considered undervalued. The incredible growth rate counters the high P/E ratio.
 
3) In our third example, a company with a P/E ratio of 10, which is well within the value parameters for most investors and is usually considered pretty cheap, has a growth rate of just 7%. Putting it into the formula, you get a PEG ratio of 1.43 (10/7= 1.43), which is much too high to be considered undervalued despite the company's rather low P/E.

Have your cake and eat it too
The great thing about the PEG ratio is that it gives you two potent weapons: both value and growth. In investing, this combination is explosive. And it's easy to deploy in your investing strategy as it's already calculated for you on most investing web sites.
 
If you can combine these two factors, your odds of investing in companies with great prospects increases. But, like using the P/E ratio to find value stocks, it shouldn't be the sole factor you look at when deciding what companies to invest in.
 
If you deploy the PEG ratio along with other criteria the PEG ratio becomes a great screening tool.
 
Value investors really CAN get value and growth in the same stock.
 
Tracey Ryniec is Zacks' Value Stock Strategist and serves as editor in charge of the Value Investor. You can follow her on twitter at @TraceyRyniec.
 
The information contained in this article should not be construed as investment advice or as a solicitation to buy or sell any stock. Nothing published by Physician’s Money Digest should be considered personalized investment advice. Physician’s Money Digest, its writers and editors, and Intellisphere LLC and its employees are not responsible for errors and/or omissions.



RELATED ARTICLES
Most Americans know that a given medical service could cost a significantly different amount depending on where one receives the service, but only recently have cost data about healthcare charges become widely available and widely discussed. National Nurses United earlier this year evaluated US hospitals to find out how much they charge for a procedure versus the actual cost of performing the procedure.
If you somehow managed to avoid the 5 worst trading days each year, you could have earned a staggeringly high return on your investments. Here are a list of other surprising figures that could have a significant impact on your wallet.
There are cycles to markets and no one really knows when a small hiccup or a seismic shift may occur. Although the market over the past weeks has rattled some investors, the advice from advisors seems to be hold your course and do not do anything rash.
RECENT CLINICAL ARTICLES
Seniors who wear their dentures when they sleep are at increased risk for pneumonia, according to a study published online Oct. 7 in the Journal of Dental Research.
New York and New Jersey health officials announced today that all health care workers returning from caring for patients in Ebola hot zones in West Africa will have to go into quarantine for 21 days. The new policy is stricter than the current one recommended by the US Centers for Disease Control and Prevention that calls for health monitoring for 21 days. It was that policy that allowed Craig Spencer, MD to be out and about a day before he was diagnosed with Ebola Thursday and rushed to city-run Bellevue Hospital Center in Manhattan.
N-terminal pro-B-type natriuretic peptide (NT-proBNP) modestly improves cardiovascular disease (CVD) risk prediction for women, according to a study published in the Oct. 28 issue of the Journal of the American College of Cardiology.