Thursday, January 28, 2010

PEG - the way to an undervalued stock

Investment Ideas

5 Stocks with Magic PEG Ratios

By: Tracey Ryniec
January 21, 2010 | Comments: 1
Recommended this article (6)

What if you could find a stock that not only was undervalued but had the possibility of big growth? I know what you're thinking, that it's nearly impossible to find those stocks. It's the holy grail of investing: a value stock that also has growth.

But here's a little secret. They do exist.

And no, they're not some $1 stock with little volume or other risky fundamentals.

Using the PEG Ratio to Find Great Stocks

Benjamin Graham, long considered to be the "father" of value investing, found that a low price-to-earnings ratio wasn't enough to unearth the true undervalued companies. He looked to the PEG ratio instead which combined both value and growth.

The PEG ratio is calculated by taking the price-to-earnings (P/E) ratio and dividing it by the growth rate.

Screening for PEG ratios under 1.0, which is considered the "magic" number for undervalued stocks, I was able to find dozens of companies that are cheap, have double digit growth and a Zacks Rank of #1 (strong buy) or #2 (buy).

Even though we've seen a huge stock market rally over the last 9 months, companies with low PEG ratios are clearly still out there.

I whittled down that list to 5 companies that are dirt cheap and have outstanding fundamentals.

5 Stocks With Magic PEG Ratios

Deckers Outdoor Corporation (DECK - Analyst Report), the manufacturer of the ever-popular UGG Australia brand of shoes and boots, has a PEG ratio of only 0.56.

The third quarter was a record quarter as UGG sales jumped 19.1% worldwide. Analysts expect 5-year earnings growth of 22.63%. The Zacks #2 Rank (buy) stock has a forward P/E of 12.8.

Force Protection Inc. (FRPT - Snapshot Report) trades with a PEG ratio of 0.57. The company manufactures ballistic- and blast-protected vehicles which have been recently been used in Iraq and Afghanistan.

Given the increased troop deployment to Afghanistan, analysts are projecting 5-year earnings growth of 20%. Force Protection is a Zacks #2 Rank (buy) stock and has a forward P/E of only 11.5.

Corinthian Colleges (COCO - Snapshot Report) hasn't gotten much love from investors even as it has surprised on estimates 4 quarters in a row. The higher education company which offers associates, bachelor's and master's degrees in a host of areas, has seen explosive growth during the recession as people return to school to train for new careers.

Corinthian Colleges has a PEG ratio of just 0.35. In fiscal 2010, Corinthian is projected to grow earnings by 87%. Growth isn't expected to be limited to just this year as analysts see 5-year earnings growth of 24.09%. The Zacks #2 Rank (buy) stock is trading with a forward P/E of just 8.5.

You can see the recent weakness in the stock in the 1-year chart below.

Teva Pharmaceuticals (TEVA - Analyst Report) seems an unlikely candidate to be both a value stock and have growth. But the generic drug giant has expanded its business due to its acquisition last year of Barr Pharmaceuticals.

Analysts expect big earnings growth in 2010 of 34.41% and project five-year earnings growth of 21.66%. The company has a tremendous history of beating estimates. The last time it missed was in 2007.

Teva has a PEG ratio of 0.60. It is trading at 12.9x forward earnings. Teva is also a Zacks #2 Rank (buy) stock.

True Religion Apparel Inc. (TRLG - Snapshot Report) has a strong brand in a hot segment of the clothing market: jeans.

The company has been able to grow even during the rough retail environment of 2009. By the end of the third quarter of 2009, True Religion had 66 retail stores compared to just 36 stores the year before. It forecast having 70 stores by the end of 2009.

True Religion sports a PEG ratio of only 0.23 as analysts expect big 5-year earnings growth of 43.5%. On a purely PEG ratio basis, True Religion is the best value of all of these 5 stocks. The Zacks #2 Rank (buy) stock is trading at just about 10x forward earnings.

The Holy Grail of Investing Does Exist

Value stocks don't have to be boring. Growth stocks don't have to be expensive. The Holy Grail of investing does exist if you dig deep enough. Use the magic of a low PEG ratio to find great growth stocks.

Tracey Ryniec is the Value Stock Strategist for She is also the Editor in charge of the market-beating Zacks Value Trader service.