In the equity market, investments always need to be prudently hedged in order to overcome uncertainties and limit losses related to external shocks. A question that often arises is whether one should resort to a value strategy that seeks discounted stocks or opt for growth investing in times of extreme market instability.
The investing track of the Oracle of Omaha over the past few decades and his gradual shift from being a pure-play value investor to a GARP (growth at a reasonable price) investor might give us all the answers.
Several stocks that have surged significantly in recent years demonstrate the overwhelming success of this hybrid investing strategy over pure-play value and growth investments. Here, we will discuss the success of four such stocks. These are Jazz Pharmaceuticals JAZZ, Fresenius Medical Care AG & Co. FMS Dana Incorporated DAN and Itron Inc ITRI.
More on GARP
The GARP theory enables strategic mingling of growth and value-investing principles, which gives us a hybrid strategy by utilizing the best features of both. What GARPers look for is whether or not the stocks are somewhat undervalued and have solid sustainable growth potential (Investopedia).
PEG Ratio and GARP
GARP investing gives priority to one of the popular value metrics — the price/earnings growth (PEG) ratio. Although it is categorized under value investing, this strategy follows the principles of both growth and value investing.
The PEG ratio is defined as (Price/ Earnings)/Earnings Growth Rate.
It relates stocks’ P/E ratio with their future earnings growth rates.
While P/E alone gives an idea of stocks that are trading at a discount, PEG, while adding the growth element to it, helps identify stocks with solid future potential.
A lower PEG ratio, preferably less than 1, is always better for GARP investors.
Say for example, if a stock's P/E ratio is 10 and the expected long-term growth rate is 15%, the company's PEG will come down to 0.66, a ratio indicating both undervaluation and future growth potential.
Unfortunately, this ratio is often neglected due to investors' limitations to calculate the future earnings growth rate of a stock.
There are some drawbacks to using the PEG ratio, though. It does not consider the very 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 over the long term.
Hence, PEG-based investing can be even more rewarding if some other relevant parameters are also 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.)
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.
Our Picks
Here are four out of the nine stocks that qualified the screening:
Jazz: Dublin, Ireland-based Jazz is a specialty biopharmaceutical company with a focus on neuroscience and oncology. The company derives most of its revenues from its sleep disorder drugs — Xywav and Xyrem. Further, the oncology portfolio accounts for nearly 30% of the company’s product revenues.
The stock can be an impressive value investment pick with its Zacks Rank #2 and a Value Score of A. Apart from a discounted PEG and P/E, Jazz also has an impressive long-term expected earnings growth rate of 7.3%.
Fresenius Medical: Based in Bad Homburg, Germany, Fresenius Medical is one of the largest integrated providers of products and services for individuals undergoing dialysis following chronic kidney failure. The company manufactures a variety of durable medical devices used for the treatment of End Stage Renal Disease.
The stock can also be an impressive value investment pick with its Zacks Rank #1 and a Value Score of A. Apart from a discounted PEG and P/E, the stock also has a solid long-term expected growth rate of 11.9%.
You can see the complete list of today’s Zacks #1 Rank stocks here.
Dana: The company, together with its subsidiaries, provides power-conveyance and energy-management solutions for vehicles and machinery in North America, Europe, South America, and the Asia Pacific. The company’s products include drive systems, including axles, driveshafts, transmission, wheel and track drives, motion systems and electrodynamic technologies.
Apart from a discounted PEG and P/E, the stock has a Value Score of A and holds a Zacks Rank #1. The stock also has a 19.3% earnings growth rate for the next five years.
Itron: Headquartered in Liberty Lake, WA, Itron is a technology and services company and one of the leading global suppliers of a wide range of standard, advanced, and smart meters and meter communication systems to the utility and municipal sectors. The company generates revenues from three operating segments, namely Device Solutions, Networked Solutions and Outcomes.
The stock can be an impressive value investment pick with its Zacks Rank #2 and a Value Score of B. Apart from a discounted PEG and P/E, the stock also has an impressive long-term expected earnings growth rate of 29%.
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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.
Disclosure: Performance information for Zacks’ portfolios and strategies are available at: https://www.zacks.com/performance.
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Itron, Inc. (ITRI) : Free Stock Analysis Report
Fresenius Medical Care AG & Co. KGaA (FMS) : Free Stock Analysis Report
Jazz Pharmaceuticals PLC (JAZZ) : Free Stock Analysis Report
Dana Incorporated (DAN) : Free Stock Analysis Report
This article originally published on Zacks Investment Research (zacks.com).
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