Value investors have long looked to the price-to-earnings ratio as a means to finding value stocks. However, 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.
Graham combined the low price-to-earnings ratios with the power of growth by using the PEG ratio. The PEG ratio is calculated by taking the price-to-earnings (P/E) ratio and dividing it by the growth rate.
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Normally, a stock with a PEG ratio under 1.0 is considered a “value”. But since the stock market decline of the past few months, quite a few stocks are now trading with PEG ratios far lower.
Screening for PEG
I created a screen for PEG ratios under 0.25, which would be an extremely low PEG ratio, on Zacks free Custom Screener. Just this one criteria gave me 86 stocks.
All 86 companies are not necessarily good value stocks. I eliminated companies that had a Zacks rank of 4 or 5 and then considered other fundamentals such as earnings surprises, return on equity and earnings history.
3 Stocks with Low PEG Ratios and Solid Value Fundamentals
The following 3 companies stood out because they had both stellar value fundamentals, including a low PEG ratio, and a solid business story.
Transocean Limited (RIG), the world’s largest offshore drilling contractor, has a PEG ratio of just 0.13. It is trading with a forward P/E of 4.7. Analysts expect 5-year earnings growth of 30%.
RIG is a Zacks #3 Rank (hold) stock. However, Zacks Equity Analyst Sheraz Mian has a “buy” rating on the stock, stating “Transocean continues to generate significant cash flows supported by a $38.7 billion backlog, which is of very high credit quality. The company is deploying its ample cash flows to strengthen its balance sheet, invest in its newbuild program, and return cash to shareholders through buybacks.”
Agrium Inc. (AGU), the Calgary-based fertilizer and agriculture services company, has a PEG ratio of 0.15. Its forward P/E is only 5.58. Analysts expect 5-year earnings growth of 40.1%.
AGU is also a Zacks #3 Rank (hold) stock. Zacks Equity Analyst Paul Raman has a “hold” on the stock due to the impact of the global credit crisis on farmers and volatility in fertilizer prices.
“Agrium is growing through acquisition and organic expansion. The acquisition of United Agri-Products (UAP) is driving revenues and profits supported by an expanded product line in the major business segment,” he said.
Shengdatech, Inc. (SDTH), a Chinese-based chemical company specializing in manufacturing nano precipitated calcium carbonate (“NPCC”), has a PEG ratio of 0.25. The company has a forward P/E of 7.72. Analysts project 5-year earnings growth of 20.67%.
SDTH is a Zacks #3 Rank (hold) stock. On Apr 2, the company announced record fourth quarter results and also saw revenue for 2008 exceed the company’s prior guidance. It has surprised on estimates 4-quarters in a row by an average of 16.94%.
Low PEG Ratios Are the Beginning Not the End
Seeking a low PEG ratio is a good way to begin a search for value stocks but it’s not the only indicator. As outlined here, start with the PEG ratio and also screen for other fundamentals. Combined with other value indicators, the PEG ratio can be a powerful tool for value investors.