For years, investors have debated whether higher returns are achieved by investing in growth or investing in value. But what if there is a way to get the best of both worlds?
Finding Undervalued Stocks
To find undervalued stocks, the Price/Book (P/B) and Price/Sales (P/S) ratios are better and more consistent indicators.
- The P/S ratio reflects how many times over investors are paying for a each dollar of company's sales, and complements the Price/Earnings (P/E) ratio well.
- The Price/Book ratio, on the other hand, is not so consistent if used by itself. A low P/B ratio could either mean that the stock is clearly undervalued, or it could also mean that the company has fundamental problems.
Finding High Growth Stocks
To find high growth stocks, look at EPS trends over a period of time, such as Forward EPS Long-Term Growth (3-5 years) and EPS growth in the past year, as well as the next year. If these EPS trends are better than the overall market, it is less likely that the company is having fundamental problems.
Best of Both Worlds
To find highly undervalued stocks with good growth prospects, mix those two groups of indicators in your stock search, as it could be a mistake to rely on a single group for getting perspective on valuation.
Consider stocks with very low P/B (less than 2) and P/S ratios (less than 1.5), and with higher EPS trends of more than 15%. By using this method, you get the best of both worlds - undervalued stocks that have good EPS growth.
Icing on the cake - Analyst ratings
Apart from these indicators, take serious note of what the analysts are telling you about the company. First Call Recommendations are easily available on most investment brokerages or websites. Apply First Call consensus of Buy or Higher to the list of stocks that we get from applying the Value and Growth indicators.
Note: Investors may use other analyst ratings instead of First Call Recommendations, or a combination of multiple ratings to be sure of selecting best prospects.
(1) Ashland Inc (ASH)
Ashland is a diversified global specialty chemical company that operates in segments such as Specialty Ingredients, Water Technologies, Performance Materials, and Consumer Markets.
- Price: $69.40
- 52-week range: $41.11 - $70.30
- Dividend Yield: 1.30%
- P/B: 1.27
- P/S: 0.71
- EPS Growth (Est. this Yr vs. Last Yr): 66.84%
- EPS Growth (Est. Next Yr vs. This Yr): 21.58%
- Forward EPS Long Term Growth (3-5 Yrs): 17.15%
- Risks: Sustained sluggish economy, high input costs.
(2) Lithia Motors Inc. (LAD)
Lithia sells new and used vehicles through it's dealerships in the western part of United States. The company is also involved in arranging finance, warranty and credit insurance contracts, and providing parts and service.
- Price: $24.92
- 52-week range: $13.57 - $27.99
- Dividend Yield: 1.60%
- P/B: 1.7
- P/S: 0.23
- EPS Growth (Est. this Yr vs. Last Yr): 26.35%
- EPS Growth (Est. Next Yr vs. This Yr): 10.29%
- Forward EPS Long Term Growth (3-5 Yrs): 21.13%
- Risks: Low vehicle demand and production, underperformance by Chrysler which is a main revenue contributor.
(3) Johnson Controls Inc. (JCI)
Johnson Controls supplies building controls and energy management systems, automotive seating and batteries in the Auto Parts/Equipment industry.
- Price: $27.49
- 52-week range: $24.29 - $41.62
- Dividend Yield: 2.60%
- P/B: 1.61
- P/S: 0.44
- EPS Growth (Est. this Yr vs. Last Yr): 11.03%
- EPS Growth (Est. Next Yr vs. This Yr): 21.25%
- Forward EPS Long Term Growth (3-5 Yrs): 17.04%
- Risks: Sustained sluggish economy, low vehicle production, lower than expected demand in aftermarket auto parts, high input costs, stronger US Dollar and worsening of Eurozone crisis.
(4) Raymond James Financial Inc. (RJF)
Raymond James Financial Inc. offers securities brokerage, investment banking, financial planning and advisory services.
- Price: $34.01
- 52-week range: $23.16 - $38.18
- Dividend Yield: 1.60%
- P/B: 1.51
- P/S: 1.29
- EPS Growth (Est. this Yr vs. Last Yr): 13.70%
- EPS Growth (Est. Next Yr vs. This Yr): 23.05%
- Forward EPS Long Term Growth (3-5 Yrs): 17.00%
- Risks: Sustained and long term economic turmoil and volatility in the markets.
Note: JCI and LAD both belong to the Consumer Discretionary sector, which is expected to perform Marketweight in the near term. Investors should opt to diversify their portfolios and not initiate long term positions in more than one stocks of the same sector.
By finding the right mix of value and growth in high quality stocks using fundamental ratios, investors can get high and consistent returns on their portfolios. Interestingly all the four stocks that we were able to find here offer some dividend yield, which is always welcome.