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Value on the Move: Screening for Low PEG Ratio Stocks

by Cara Scatizzi

Value On The Move: Screening For Low PEG Ratio Stocks Splash image

It is not uncommon for a value investor to worry about being caught in a “value trap.” This occurs when a stock appears to be attractive based on valuation multiples, but the price remains depressed. The trap is that the stock’s seemingly low price is actually appropriate. The value trap can also occur when a stock is undervalued, but other investors fail to catch on to this mispricing.

A good way to avoid this problem is to look for stocks that have characteristics besides a low valuation that justify a higher price. Two screens highlighted in this article are designed to identify such stocks.

Overview of the Screens

AAII’s fundamental stock screening and data research program, Stock Investor Pro, has two screens that isolate value stocks exhibiting earnings growth and price appreciation. These screens are also accessible on AAII.com and are labeled as “Value on the Move.” Both combine the price-earnings-to-growth ratio PEG with other criteria to capture value stocks on an upward trajectory. The screens are called Historical Growth PEG and Estimated Growth PEG.

The PEG ratio is an alternative calculation to the price-earnings ratio in that it accounts for growth in earnings. This ratio attempts to examine whether a stock’s price is out of line with earnings and the earnings growth rate. It compares a stock’s price-earnings ratio to its growth rate in earnings. You can use the current or future price-earnings ratio and a historical earnings growth rate or a future, estimated earnings growth rate.

The Historical Growth PEG screen uses the trailing 12-month price-earnings ratio (the current price divided by the sum of earnings for the most recent four quarters) and the five-year growth in diluted continuing earnings per share. The problem with using only historical information is that markets are forward looking, meaning that investors factor in expected future growth. Good historical growth does not automatically mean that strong future growth is in the cards.

The Estimated Growth PEG screen uses a forward price-earnings ratio (the current price divided by the consensus earnings per share estimate for the current fiscal year) and the estimated three-to-five-year growth rate in earnings per share.

Companies that have experienced high past growth are often expected to continue that growth. These stocks may trade with higher price-earnings ratios than stocks with low growth expectations. In general, a stock with a PEG ratio of 1.0 is considered fairly priced. A PEG ratio below 1.0 may point to underpricing relative to expected earnings, and a PEG ratio above 1.0 may indicate that a stock is overvalued.

AAII’s Value on the Move screens look for companies with:
• historical or estimated PEG ratio between 0.2 and 1.0;
• positive earnings over the last 12 months and five fiscal years;
• positive earnings growth, quarter-over-quarter, for the last four quarters; and
• 26-week relative strength in the top 70% of the Stock Investor database.

Screen Performance

Figure 1 shows the historical performance of AAII’s two Value on the Move stock screens. Both screens have outpaced all of the indexes over the cumulative period from 1998 to May 31, 2010. The Historical Growth PEG screen has gained a cumulative 409.1%, while the Estimated Growth PEG screen has gained over twice that amount (846.4%).

Interestingly, these screens have seen only one calendar year with negative performance: 2008. The losses during that timeframe were on par with the overall market’s decline, as shown in Figure 1. During the downturn of 2002, when all of the listed indexes were down, the Historical Growth PEG screen gained 12.1% and the Estimated Growth PEG screen gained 7.9%.

The first five months of 2010 have proven tough for many investors, but both PEG screens are easily outpacing the indexes. On a year-to-date basis, each has topped 10% compared to a loss of 2.3% for the S&P 500.

While both PEG screens have outperformed the indexes over various time periods, they have a similar level of risk (as measured by monthly standard deviation) when compared to the indexes. The overall standard deviations are 5.0% for the Historical Growth PEG screen and 6.3% for the Estimated Growth PEG screen. Compare this to a standard deviation of 4.7% for the S&P 500 index; 5.7% for the S&P MidCap 400 index; and 6.0% for the S&P SmallCap 600 index.

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Portfolio Characteristics

Table 1 shows the characteristics of the passing companies for each of the screens and for all exchange-listed stocks. Because the screens are focused on finding value stocks, it is unsurprising that both screens produce lists of companies with price-earnings ratios that are lower than the universe of exchange-traded stocks. The current passing companies from the Historical Growth PEG screen have a median price-earnings ratio of 15.9. The companies passing the Estimated Growth PEG screen have a median price-earnings ratio of 14.1, and the median for all exchange-traded stocks is 17.7.

Portfolio Characteristics (Median) PEG Ratio Exchange-
Historical
Growth
Estimated
Growth
Traded
Stocks
Price-earnings ratio (X) 15.9 14.1 17.7
Price-to-book-value ratio (X) 3.2 2.1 1.5
Price-to-sales ratio (X) 1.4 1.0 1.4
Price-earnings-to-EPS est growth (X) 1.1 0.9 1.3
Price-earnings-to-EPS hist growth (X) 0.6 0.9 1.1
EPS 5-yr. historical growth rate (%) 25.4 17.7 –0.5
EPS 5 yr. estimated growth rate (%) 15.3 15.0 12.4
Market cap. ($ million) 1108.3 1420.0 427.9
Relative strength vs. S&P (S&P=0) (%) 39 25 4
Monthly Observations
Average no. of passing stocks 90 44  
Highest no. of passing stocks 216 138  
Lowest no. of passing stocks 11 6  
Monthly turnover (%) 36.6 44.2  

What is surprising is that the median price-to-book-value ratios for the PEG screens are higher than the median for all exchange-listed stocks. One reason could be that the screens are capturing an upward movement in price, which also pushes the price-to-book ratio higher. In addition, many stocks have fallen in value in recent history at the same time that companies are increasing their cash balances, causing the overall market’s price-to-book ratio to be much lower than the last time these screens were featured in the AAII Journal (September 2006).

Due to the PEG ratio restrictions (it must be between 0.2 and 1.0 for both screens), it is expected that the median for all exchange-listed stocks will be higher for both data points, and this holds true. The median historical PEG ratio for exchange-listed stocks is 1.1, compared to 0.6 for the stocks meeting the Historical Growth PEG criteria. The median estimated PEG ratio for exchange-listed stocks is 1.3, while for stocks meeting the Estimated Growth PEG screen it’s 0.9.

The historical and estimated earnings per share growth rates are higher for stocks meeting either PEG screen when compared to the respective median growth rates for exchange-listed stocks.

Finally, the Historical Growth PEG ratio screen has an average of 90 passing companies each month, with the highest number in a single month being 216. Also, the screen has an average monthly turnover of 36.6%. The Estimated Growth PEG screen has an average of 44 companies passing each month, with the largest number of passing companies in one month being 138. The screen’s average monthly turnover is 44.2%.

Passing Companies

Table 2 lists the top 20 passing companies based on both the lowest historical and the lowest estimated PEG ratios as of May 31, 2010. A total of 29 stocks met the Historical Growth PEG screen and 21 met the Estimated Growth PEG screen.

Company (Exchange: Ticker) PEG Ratio Current
P/E
Ratio
(X)
EPS Grth Rate Rel Strgth Price as
% of
52-Wk
High
 
Hist
Grth
(X)
Est
Grth
(X)
 
Hist
(%)
Est
(%)
Q5-Q1
(%)
26-Wk
(%)
52-Wk
(%)
 
Description
Historical Earnings Growth PEG*
Amedisys, Inc. (M: AMED) 0.3 0.5 9.6 33.4 16.4 30.7 78 78 77 home health servs
Aeropostale, Inc. (N: ARO) 0.4 0.7 11.3 28.0 14.0 54.8 79 52 86 casual apparel
Chipotle Mexican Grill (N: CMG) 0.4 1.4 32.6 75.4 19.9 51.9 92 82 96 Mexican fast food
Credit Acceptance (M: CACC) 0.4 10.1 26.7 8.4 84 91 88 auto loans
Steven Madden (M: SHOO) 0.4 15.9 35.2 124.0 83 84 82 footwear
NVE Corp. (M: NVEC) 0.4 0.6 18.8 45.7 25.0 14.9 73 49 73 nanotech devices
World Acceptance (M: WRLD) 0.4 8.0 19.7 8.6 72 84 81 consumer loans
Buckle, Inc. (N: BKE) 0.5 1.1 12.7 25.4 11.3 10.2 77 34 88 casual apparel
Deckers Outdoor (M: DECK) 0.5 0.6 15.4 31.7 22.6 47.9 89 93 91 footwear
Ensign Group (M: ENSG) 0.5 0.7 11.3 24.0 15.0 15.4 77 50 96 nursing & rehab
SXC Health Solutions (M: SXCI) 0.5 39.3 74.3 53.1 85 95 98 pharm benefit servs
Ulta Salon (M: ULTA) 0.5 1.2 38.8 80.2 24.0 66.7 89 95 98 beauty retailer
BofI Holding, Inc .(M: BOFI) 0.6 9.4 11.9 106.5 93 93 83 Web bank holding co
MWI Veterinary Sply (M: MWIV) 0.6 1.3 21.1 32.7 16.0 31.3 81 80 94 animal health prods
PetMed Express (M: PETS) 0.6 1.1 17.6 27.0 14.8 19.0 70 64 80 pet pharmacy
Daily Journal (M: DJCO) 0.7 11.8 17.4 4.2 79 74 95 newspaper publisher
Famous Dave’s (M: DAVE) 0.7 0.7 11.1 16.8 17.2 100.0 84 67 88 restaurant chain
Hasbro, Inc. (N: HAS) 0.7 1.6 14.7 19.4 10.0 207.1 82 80 94 toys & games
Jos. A. Bank Clothiers (M: JOSB) 0.7 15.8 21.5 16.3 85 78 93 men’s apparel
Stanley, Inc. (N: SXE) 0.7 1.4 19.2 28.6 12.5 10.9 83 70 99 IT servs to gov’t
Estimated Earnings Growth PEG**
Amedisys, Inc. (M: AMED) 0.3 0.5 9.6 33.4 16.4 30.7 78 78 77 home health servs
Continucare Corp. (A: CNU) 0.9 0.6 11.1 12.3 20.0 42.9 76 83 74 primary care phys
Deckers Outdoor (M: DECK) 0.5 0.6 15.4 31.7 22.6 47.9 89 93 91 footwear
EZCORP, Inc. (M: EZPW) 0.2 0.6 10.6 42.1 15.0 28.9 74 74 77 credit service
NVE Corp. (M: NVEC) 0.4 0.6 18.8 45.7 25.0 14.9 73 49 73 nanotech devices
Aeropostale, Inc. (N: ARO) 0.4 0.7 11.3 28.0 14.0 54.8 79 52 86 casual apparel
Ensign Group (M: ENSG) 0.5 0.7 11.3 24.0 15.0 15.4 77 50 96 nursing & rehab
Famous Dave’s (M: DAVE) 0.7 0.7 11.1 16.8 17.2 100.0 84 67 88 restaurant chain
Summer Infant (M: SUMR) 0.7 18.8 24.0 266.7 94 97 98 child safety prods
Capella Education (M: CPLA) 3.2 0.9 29.5 8.7 26.3 80.0 71 80 88 postsecondary educ
Community Health (N: CYH) 1.4 0.9 14.1 9.4 14.2 20.6 74 72 92 hospitals
Unum Group (N: UNM) 0.2 0.9 8.4 42.0 9.2 38.0 72 64 87 life insurance
AutoZone, Inc. (N: AZO) 1.1 1.0 13.8 12.3 13.2 31.8 76 57 98 auto replace parts
Big Lots, Inc. (N: BIG) 0.2 1.0 13.2 54.6 12.3 53.3 86 76 85 closeout retailer
Dollar Tree, Inc. (M: DLTR) 1.0 1.0 17.1 17.7 14.1 10.4 74 67 98 discount stores
Encore Capital Gp (M: ECPG) 2.2 1.0 14.6 6.2 12.5 17.9 82 79 87 buys charged-off credit
Monro Muffler Brake (M: MNRO) 2.9 1.0 26.8 8.4 20.9 37.9 80 73 99 auto repair & tires
99 Cents Only Stores (N: NDN) 1.0 1.0 17.6 17.7 15.5 150.0 74 79 84 closeout retailer
Rent-A-Center (M: RCII) 1.7 1.0 9.3 5.0 8.6 13.0 81 56 84 installment sales
Texas Roadhouse (M: TXRH) 1.7 1.0 20.0 10.1 17.3 28.6 84 57 90 restaurant chain

The company with the lowest historical and estimated PEG ratio is Amedisys, Inc. AMED; the stock passes both screens. Amedisys provides home healthcare nursing services. Healthcare is obviously a growing industry and there is much potential for companies involved in elder care services. Amedisys’ earnings have grown at 33.4% annually over the last five years and are expected to grow at a lower 16.4% per year in the future. Shares of AMED peaked in price at $62.99 on April 13, 2010. The stock price proceeded to fall to a low of $46.82 on May 25, 2010 before bouncing back to close the month of May at $49.72. The S&P 500 followed a similar trajectory, falling 9% from April 13 to the close of May.

As Amedisys’ stock price fell and earnings growth rates remained unchanged, the PEG ratios became more attractive. Because the overall market performed poorly, AMED shares still rank in the 78th percentile for 26-week relative strength, even after the steep drop in mid April.

What It Takes: Value on the Move Criteria

  • The ratio of the price-earnings ratio to the growth rate in earnings per share (five-year historical growth for the Historical Growth PEG screen, or three- to five-year estimated growth rate for the Estimated Growth PEG screen) is less than or equal to 1.0 and greater than 0.2
  • Earnings per share from continuing operations for the last 12 months and for each of the last five fiscal years are positive
  • Earnings per share from continuing operations for each of the last four fiscal quarters is greater than the same quarter one year earlier
  • The 26-week relative price strength ranks in the top 70% of the entire database\

Conclusion

Value stocks are appealing to many investors, and numerous studies show outperformance by these stocks over various time periods. It is important to understand that just because a stock’s price has fallen does not automatically make it a good investment. It is easy to fall into the value trap. AAII’s Value on the Move screens attempt to isolate stocks exhibiting characteristics of value stocks with recent upward trajectories in earnings and prices.

Remember that these stock screens are not a list of recommended stocks. The screens are tools that allow you to isolate companies with similar quantifiable characteristics. However, it is important to perform additional due diligence on any company that passes a stock screen. The end goal is to find stocks that match your investing timeframe, tolerances and constraints.

 

Click here for the latest passing companies and performance data

 

Cara Scatizzi is a former associate financial analyst at AAII.


Discussion

Girishbhai from FL posted over 4 years ago:

Current information about the company is important in making a decision. AMED is under investigation for possible fraud in medical billings. Recent information is not translated in the data. Because it takes few years to show up. One should investigate extreme outliers in detail if one wants to invest in them.


Matt from OK posted over 3 years ago:

Good example of why you need to go beyond the numbers. AMED is pointed out as attractive based on the screen, but they are in the middle of a potential class action lawsuit claiming that earnings were misrepresented based on medicare fraud.


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