By Matt Doiron
One way to account for a stock's upside potential is the PEG ratio, which incorporates both the P/E multiple favored by value investors and the consensus earnings growth rate based on the projections of Wall Street analysts. Of course, analyst forecasts are not always accurate, but the PEG ratio at least serves as one tool to help account for the possibility of a company growing its earnings. We track quarterly 13F filings from hundreds of hedge funds, including billionaire David Tepper's Appaloosa Management, as part of our work researching investment strategies (we have found, for example, that the most popular small cap stocks among hedge funds earn an average excess return of 18 percentage points per year), and so we can also look at individual managers' filings we like which feature low PEG ratios. Read on for our quick take on the five largest holdings in Appaloosa's portfolio as of the end of March with five-year PEG ratios less than 0.7, see the full 13F on the SEC's website, and compare these picks to those in previous filings.
One of the fund's top picks for the second quarter of 2012, was United Continental (NYSE:UAL) with the 13F disclosing ownership of 8.5 million shares. A large share of the investment community hates airlines given their tendency to go bankrupt, which results in low valuations relative to analyst expectations for the next few years (and low PEG ratios as the sell-side does generally expect earnings growth as well). However, some value investors have been buying into the industry in the past few quarters on the theory that US Airways' purchase of American will increase industry consolidation and therefore airlines' pricing power.
Tepper and his team cut their stake in Apple (NASDAQ:AAPL) but still owned 540,000 shares of the stock per the filing. Apple's earnings were down 18% in its most recent quarter compared to the same period in the previous fiscal year, as considerably lower margins offset higher revenue. Markets are expecting that net income will continue to decline, as both Apple's trailing and forward P/Es come in at 10 even with a sizable portion of the market cap being cash. The PEG ratio is low, however, as analysts are generally looking for earnings growth over the next several years.
Appaloosa slightly increased its holdings of Goodyear (NYSE:GT) and had over 15 million shares of the tire manufacturer in its portfolio. Analyst consensus for Goodyear is very optimistic, with earnings expectations for 2014 implying a forward P/E of 6. The company is fairly dependent on the broader economy, and as a result the stock's beta is 2.2; in addition, Goodyear faces potential problems with its pension obligations (though it did shift its pension strategy earlier this year). In addition, sales have actually been down and so it might prove too risky.
US Airways (LCC) itself was one of Tepper's high upside potential picks. The combined US Airways-American will of course experience integration risks, and as a result we are somewhat more interested in looking at other airlines, but some bulls argue that the merger will particularly reduce competition on many routes where US Airways and American currently combine for a large market share. Currently the stock trades at 6 times forward earnings estimates. The most recent data shows that about a third of the float is held short, following a 75% rise in price over the last year.
Tepper is a fan of airlines: rounding out our list of his low-PEG picks is Delta Air Lines (NYSE:DAL), which Appaloosa owned 9.8 million shares of at the beginning of April. Currently valued at 6 times expected earnings for 2014 (though this does represent high expectations in terms of increased EPS over the next several quarters), Delta's also boasted a significant rise in its stock price in the last year. We think that investors shouldn't be rejecting the airline industry out of hand, and while analyst estimates shouldn't be taken as fact these stocks could be interesting value opportunities.
Disclosure: I am long AAPL.
Business relationship disclosure: This article is written by Insider Monkey's writer, Matt Doiron, and edited by Meena Krishnamsetty. They don't have any business relationships with any of the companies mentioned in this article and they didn't receive compensation (other than from Insider Monkey and Seeking Alpha) to write this article.