It’s tough to be a value investor these days. Despite claims that this would be the worst earnings season in recent memory, many stocks that were already considered to be overvalued are continuing to surge forward based on news that is “better than feared”. This goes against the mantra of the value investor which is to buy stocks at prices that are below the company’s intrinsic value.
Stocks are always on sale
Nevertheless, stocks are always on sale, you just have to know where to look. For value investors, finding a stock on sale does not necessarily mean a stock that is in a selloff. Rather, you are looking for stocks that are cheap relative to their industry.
There is no perfect formula for finding an undervalued stock. For example, some investors like to use the price-earnings (PE) ratio as a measurement. This is easy to find or calculate if necessary, but like many valuation ratios, PE is a measurement of a company’s current earnings and cash flow. However, as an investor, you’re more interested in how well the company will be able to generate earnings and cash flow in the future.
Another data point that some fundamental analysts look at is a company’s discounted cash flow (DCF). A DCF model determines the present value of a company based on the value of money it can make in the future. It can also be useful in providing an estimate of a company’s intrinsic value. One of the problems with DCF is using it to determine a company’s intrinsic value requires a large number of assumptions that can be sensitive to change for a variety of reasons.
How to use the PEG ratio to find stocks on sale
Still, investors need to have some objective metric to find undervalued stocks. A different approach is to look at a company’s price-to-earnings growth (PEG) ratio. The PEG ratio factors in the importance of growth and fundamental quality that often lead to superior performance over the long term. The PEG ratio is a company’s price-to-earnings ratio divided by the expected growth rate in earnings.
Once you know a company’s PEG ratio, you can compare it to their industry average. Then it’s a simple matter of finding companies that have a PEG ratio that is below the industry average. Of course as an investor, you still need to pay attention to other quantitative metrics such as financial quality (do they have a sound balance sheet), valuation (is the stock selling at a reasonable price), how do analysts perceive the company (is the company doing well) and finally does the company show relative strength (is the stock outperforming)?
Here are three stocks that look like a bargain
So if we use the PEG ratio as a baseline, here are a few stocks that may be a bargain right now. None of these stocks are underperforming the market, but as you can see they have a PEG ratio that is above their industry average and have strong fundamental cases for sustained, steady growth.
Oracle Corporation (NYSE: ORCL)
PEG ratio – 1.5; PEG Industry Average – 2.47
Oracle was a company that arrived on the scene with a lot of fanfare and for many years was seen as one of the great growth stocks. But recently, there’s been some confusion about exactly what kind of company Oracle is becoming. The answer lies in the clouds as Oracle is moving away from its hardware and services business to a cloud-based business model. The cloud space is expected to grow with the emergence of 5G technology and what that means for connected devices. While Oracle is not likely to see the rapid growth that will appeal to growth investors, the stock is up just under 30% year to date which is slightly above the pace of other companies in the Computer-Technology sector and slightly below the average of companies in the Computer-Software sector. At least one analyst sees Oracle with a stock price of $73 per share by May 2023. That would be an over 30% increase from its current stock price of around $55 per share. And Oracle offers a solid dividend that is also appealing to value investors.
Zix Corporation (NASDAQ: ZIXI)
PEG ratio – 1.25; PEG Industry Average – 2.47
For investors looking for a company with a lower share price (and smaller market cap), Zix Corporation is an interesting play. Although it plays in the same sector as Oracle, it is a much smaller company (its share price is currently under $10) but it occupies a sweet spot with its focus on email security. The company’s revenue saw a 76% year-over-year growth to just over $29 million. The company was expected to deliver a quarterly EPS of $0.10 per share which would be a year-over-year gain of over 40 percent with revenues also showing a significant year-over-year gain.
eBay Inc. (NASDAQ: EBAY)
PEG ratio – 1.3; PEG Industry Average – 1.51
If you’re looking for a stock in the internet commerce space that isn’t spelled Amazon, then eBay may be a good choice. The fundamentals are solid with a forward PE ratio of 14.88 and a price-to-book (PB) ratio of 8.34. The company posted second-quarter earnings that exceeded analysts’ expectations with revenue of $2.7 billion and an EPS of $0.46. The company also continues to pay a dividend with a yield of just over 1%. The company paid out $120 million in dividends in the second quarter. The company cited an accelerated adoption of its new payment platforms by sellers as one of the key drivers of its growth.