What Are You Paying For That Growth?

7/26/2010


The Forecasts looks for stocks that deliver growth at a good price — a strategy that has done well for us.

Of course, such strategies invite questions, like “How much growth is enough?” and “What constitutes a good price?”

For all such questions, context is key. Still, regardless of the market environment, a few statistics merit special attention:

Quadrix® Value score. Part of our proprietary stock-rating system, the Value score considers more than a dozen valuation metrics and calculates a percentile rank for more than 4,300 U.S.-traded stocks. In rolling 12-month periods since 1994, the top one-fifth of S&P 1500 Index stocks as measured by Value outperformed the average stock in the index by an average of 4.0%. The Value score has been more effective than the Overall score since 2000 and in back-tests to the early 1990s, though high Value scorers delivered more volatile returns.

Long-term expected profit growth. The consensus five-year growth estimate has been one of the best Quadrix factors, with top scorers outperforming the average stock in the S&P 1500 Index by an average of 3.7% annually. Long-term-growth estimates tend to be overly optimistic and static — analysts often leave five-year estimates unchanged when they alter near-term targets. Yet the statistic has proven a good indicator, especially when used with valuation ratios.

P/E ratio on current-year profit estimate. Our data for this statistic dates back only to 2004, but since then, the cheapest one-fifth of S&P 1500 stocks as measured by this ratio outperformed by an average of 3.3% in 12-month periods.

PEG ratio. To calculate this ratio, we divide the P/E ratio based on the current-year estimate by the long-term-growth estimate. The one-fifth of S&P 1500 stocks with the lowest PEG ratios outperformed by an average of 3.3% annually. The average stock in our Quadrix research universe has a PEG ratio of 1.5, and the capitalization-weighted S&P 500 Index has a PEG ratio of 1.2.

We’re not looking for the cheapest stocks or the fastest growth. Most deep values are “cheap” for good reason. The fastest-growing companies are often risky and expensive. The Quadrix Overall score helps us eliminate stocks with weak fundamentals, while the Value score can further cull the herd by eliminating the priciest options. The table below lists stocks with strong Quadrix scores, as well as PEG ratios that indicate an appealing mix of growth and value.

SCREEN OF THE MONTH
All six of the stocks below earn Quadrix® Overall and Value scores of at least 80, should deliver double-digit annual profit growth over the next five years, and have price/earnings-to-growth (PEG) ratios below 1.0. To calculate the PEG ratio, we divided the P/E on the current-year estimate by the long-term growth estimate.
Mkt.
Value
($Bil.)
Quadrix
—– Scores * –—
EPS
Growth,
Last 12
Mos.
(%)
Est.
EPS
Growth,
Next
5 Yrs.
(%)
P/E
On
Curr.-
Yr. Est.
PEG
Ratio
Company
(Price; Ticker)
Value
Overall
Aflac ($48; AFL)
22.6
92
92
16
14
9
0.64
Intel ($22; INTC)
123.6
86
98
110
13
11
0.79
Lubrizol ($88; LZ)
6.1
85
99
203
19
10
0.53
Research In Motion
($55; RIMM)
30.8
92
100
39
16
10
0.63
TJX Companies
($42; TJX)
17.4
80
99
50
14
13
0.89
Travelers
($50; TRV)
25.9
91
97
53
14
9
0.62
* Quadrix scores are percentile ranks, with 100 the best.

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