MILLBURN, N.J. (Stockpickr) -- My investment strategy seeks out stocks that are cheap relative to their growth rate -- referred to as growth at a reasonable price, or GARP. To that end, I seek out stocks that are selling at low price-earnings-to-growth, or PEG, ratios.
The price-to-earnings, or P/E, ratio is a measure of risk. It calculates the multiple of earnings an investor is willing to pay. The higher the multiple, the greater the stock price will react to changes in earnings per share. A stock sporting a lower multiple is considered safer because of the lesser impact that earnings has upon stock price. Lower-P/E stocks tend to compensate investors by paying dividends.
Back in May, I recommended four reasonably price stocks. Since that date, the S&P 500 is down over 5%. Of the four stocks, only one is down -- FedEd (FDX), which shed 9.2%. The rest have seen positive returns: Apple (AAPL) is up 15.1%, Ralph Lauren (RL) is up 9.6%, and Buffalo Wild Wings (BWLD) is up 6.4%.
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Another part of my strategy is to avoid stocks with high PEG ratios as those tend to be overpriced, be priced for perfection (that is, they leave no room for error) and invite too much risk into one's portfolio. In July, I recommended avoiding (or shorting) five stocks with high PEG ratios
. With the S&P down about 4.5% since then, Amazon (AMZN)
is down 8.6%, Fortinet (FTNT)
is down about 11.1%, Dolby Labs (DLB)
is down 20.7%, Salesforce (CRM)
is down 21.3%, and SodaStream (SODA)
is off 59.6%.
Now I'm taking my research one step further by combining PEG with beta. Beta is the sensitivity of a stock's price to that of the market portfolio. Most people use the S&P 500 as a proxy for the market portfolio.
Why use beta? Beta is a measure of market risk. I am concerned that the broad markets are stuck in an endless series of intertwined economic do-loops with a risk that they progress to a never-ending condition. A "do-loop" is a term used by computer programmers to describe repetitive tasks that are supposed to terminate upon a certain condition being satisfied. But a programming flaw could produce a never-ending do-loop that hangs the program up and could potentially cause a system crash.
Here are some of the seemingly endless economic do-loops that we're currently facing:
1. The Euro Debt Do-Loop
: Every time we seem to arrive at a solution to the problems in the eurozone, we go back to the beginning. It started with Spain. Then it went to Greece. Then to Italy. Now back to Spain. Will it ever end?
2. The Technical Do-Loop
: The S&P 500 is within a few points of where it stood on Aug. 31, Oct. 20 and just about a year ago. It seems that we have gone absolutely nowhere, in an endless market do-loop -- though we have traveled far and wide in the intervening periods between those dates. The only true winners have been the stock pickers who've been able to identify the right stocks and the brokers who have racked up huge commissions along the way.
3. The Capital Hill Do-Loop
: We suffered through the period leading up to the extension of the debt ceiling on Aug. 2. Now we have to relive this with the painful negotiations of the Super Committee. How many people will worry about another credit downgrade of the U.S. once the Super Committee comes to an agreement?
4. The Daily Futures Do-Loop
. U.S. index futures head lower after the U.S. market close, reverse into the evening, tank when Europe opens, rebound after the morning U.S. economic or earnings data is released, sell off into the European close -- and then comes the wild card, the U.S. close.
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So now, taking all of this into consideration, I am seeking companies with low risk relative to the overall markets that still exhibit reasonable prices relative to levels of earnings growth. I screened for stocks with raw beta of less than 1, PEG ratios of less than 1 and market capitalizations of more than $500 million. From the output, I ranked the stocks according to the sum of the raw beta plus the PEG ratio and analyzed each company from a fundamental perspective.
Let's take a closer look at five stocks that I consider excellent value opportunities
as we look ahead to the next year.