Thursday December 15, 2011
by J. Royden Ward, editor Cabot Bejamin Graham Value Letter
Twenty-seven years ago, Standard & Poor’s created the PEG ratio to measure the degree to which a growth stock is undervalued.
We use the ratio to ﬁnd growth stocks selling at reasonable prices. The PEG ratio is calculated by dividing the price to earnings (P/E) ratio by the earnings growth rate.
The growth rate (the “G” in the PEG ratio) is our estimated rate of EPS growth for the next ﬁve years. A PEG ratio of less than 1.00 indicates that a stock is undervalued. The lowest PEG ratios are best.
To ﬁnd undervalued stocks, we calculated the PEG ratios for the 1,000 companies contained in our Benjamin Graham database.
We selected six low-risk companies with PEG ratios below 1.00 and positive earnings forecasts. We included only companies which will likely exceed analysts’ sales and earnings forecasts.
Baker Hughes (BHI) is one of the largest oilﬁeld service companies in the world. Its $6.9 billion acquisition of BJ Services in April 2010 is providing exciting new opportunities in shale drilling.
Baker is spending heavily on new technology to stay ahead of the competition. Its technology advantage, its new entry into the oil shale business, and cost savings from BJ will help sales to increase 13% and EPS to surge 34% in 2012. BHI is low risk
CSX Corp. (CSX), which operates the largest rail network in the eastern U.S. will beneﬁt from the slowly recovering economy in the U.S.
The recession forced CSX to focus on operating efﬁciencies, which should lead to higher proﬁtability as shipments rise in 2012.
We forecast revenue growth of 10% and EPS gains of 17% in 2012. The 2.2% dividend yield is attractive, and the 0.66 PEG ratio is unusually low. CSX is low risk.
FedEx (FDX) provides worldwide on-time air express delivery; holiday shipments are likely to increase a hefty 12%, boosted by customers’ switching to online shopping.
Most importantly, the U.S. Postal Service -- FedEx’s competitor -- will cut costs and services beginning in 2012 to balance its budget.
FedEx will spend $2 billion on new aircraft to ﬂy to additional destinations. The expanded international operations will drive revenues and earnings growth in 2012 and beyond.
Revenues will likely increase by 20% and EPS by 13% during the next 12 months. The PEG ratio of 0.86 is attractive. FDX is low risk.
Johnson Controls (JCI) supplies energy-efﬁcient management systems for commercial buildings, and makes batteries, seating assemblies and interior systems for cars.
The demand for automotive seating has grown rapidly in recent years, as production, previously manufactured in-house by automakers, is outsourced to Johnson and others.
The building efﬁciency segment could get a boost from the government if a program is implemented to help commercial building owners retroﬁt buildings to gain better energy efﬁciency.
Sales will increase 8% and EPS will likely jump 25% during the next 12-month period. Founded in 1885, Johnson Controls is a top company with a very reasonable PEG ratio of 0.61. JCI pays a dividend yielding 2.2% and is low risk.
Priceline.com (PCLN) is our favorite low PEG ratio stock. It operates in 99 countries and derives 69% of revenues from international bookings.
Priceline’s “Name Your Own Price” service, which allows customers to negotiate prices for travel services, has become very popular.
Shares are volatile, but the company’s balance sheet is strong with no debt and lots of cash. Sales and earnings have soared during the past ﬁve years, and Priceline is well-positioned to produce rapid growth in future years.
The forward 12-month price to earnings ratio of 17.6 is somewhat high, but not for a company growing at a 25% clip as demonstrated by its PEG ratio of 0.69. Priceline is low risk.
Universal Health ‘B’ (UHS) owns and operates acute care and surgical hospitals, and behavioral health, ambulatory surgery and radiation oncology centers in 37 states.
The November 2010 acquisition of Psychiatric Solutions has provided a big boost to sales and earnings.
Universal is expanding its outpatient services to help reduce healthcare costs.
We expect sales and earnings to increase 11% and 16% respectively during the next 12 months. The PEG ratio of 0.75 is very reasonable. UHS is low risk.
Overall, we believe these six recommendations will produce exceptional returns during the next six to 12 months.
Learn more about this financial newsletter at J. Royden Ward, editor Cabot Bejamin Graham Value Letter.