As you know, The Rayno Report is religious about finding low-PEG stocks. Like a little child before Christmas, I get excited about finding them under the tree. Some of our low-PEG Hall of Fame stocks are Apple (Nasdaq: AAPL), Celgene (Nasaq: CELG) and Gilead Sciences (Nasdaq: GILD), low-PEGers that we found on these pages before they steadily took off like rocket ships.
What's a low-PEG stock? It's a stock that is priced by the market below its growth rate. Common wisdom is that "growth" stocks, with fast rates of profit and revenue growth, receive premium market valuation -- they have earned the right to be expensive. But what's interesting is that the market doesn't always assign a premium valuation to growth stocks. Sometimes they can be found on sale, for whatever reason: the market is skeptical of the name, the market thinks that growth will slow, there may be issues with the company, or our favorite reason -- the market is being irrational and wrong.
The reason I like the low-PEG stock strategy is that it lowers the risks you take for the potential for great rewards. Odds are, the crowd is wrong that a high-growth company should be valued below market rates. Take a look at Apple: the crowd has been proven wrong again and again.
These are the specific situations we seek: the market irrationally pricing in a cheap valuation on a quality growth name. So how is valuation "measured" and rationality assessed? Fortunately we have metrics like the price/earnings ratio and the PEG ratio. I like to define cheap or expensive in the terms of the price/earnings (P/E) ratio, which is generated by dividing the share price by the earnings per share (EPS). The PEG ratio is generated when you take the P/E ratio and divide that in turn by the earnings growth rate. Let's take an example: Let's say fictional Community Growth Corp. has a share price of $20, earnings of $2 per share, and a growth rate of 15% annual. The P/E ratio would be 10 ($20/$2) and the PEG would be .66 (10/15).
A low-PEG stock by my definition is any stock trading below a PEG of 1, meaning that it's P/E ratio is lower than its earnings growth rate. You might think by my description that low-PEG stocks are rare and hard to find. Oddly, in this market, they aren't! In fact Apple Inc. (Nasdaq: AAPL) by definition has been a low-PEG stock throughout its meteoric rise.
In fact, it seems like every time we run a stock screen of your basic Low-PEG ideas, Apple pops up. But everybody knows Apple right? Its PEG is currently an absurd .48 -- low for what is considered basically to be the best company in the world. Why is this? I think the market discounts Apple because 1) it is so huge and 2) it's worried that at any minute one of its core franchises will come under sudden pressure 3) Highly publicized manufacturing issues with labor and quality control problems in China. Apple stock just dropped $100, trading closer to $600 than its all-time high of $700. If you think any of these issues is overdone buy the thing.
What about some new stuff?
I spent some hours on the weekend looking up some screens and scouring the charts for some interesting names. Two I like that meet my valuation criteria are Syntel Inc. (Nasdaq: SYNT) and Cirrus Logic Inc. (Nasdaq: CRUS).
Syntel is an IT outsourcer based in Troy, MI. Specialities include data warehousing and Web solutions, with a focus on the financial and healthcare sectors. Syntel has very solid numbers including annual net income of about $180 million on revenue of $708 million for an operating margin of 33%. It's got zero debt and $422 million in cash -- nearly $10 per share! With Syntel's shares recently trading hands at $61, it had a forward P/E of about 15 and a PEG of .87. Pretty good numbers for a company with mounds of cash, no debt, and large margins. I love situations like this.
Stock #2 is a little more well-known -- it's Cirrus Logic Inc. Now, Cirrus Logic is a manufacturer for Apple, so if you own Apple you need to be aware of the correlation. But like Apple and Syntel, Cirrus has great numbers. What's good about it is that with a $2.4 billion valuation, there is still a lot of room for growth. Cirrus earns about $90 million per years on $433 million in revenue, for a profit margin of about 19%. It's got a return on equity (ROE) of 20. The forward P/E is 12 and the PEG is .80. All of these are good numbers, in our book. In the last year or so the company has doubled its revenues and quadrupled its profits. I don't see any reason why it can't do that again, yielding a doubling in stock price.
Those are our stocks for the week. Let's see what the screens come up with next week -- I'll have more.