One of the most common ways of determining whether or not a stock is overpriced is to compare its stock price to earnings per share, generally using the last four quarters of actual earnings reports. However, the trailing P/E does not recognize the different growth potentials of different companies. While an analyst might use the forward P/E ratio based on consensus expectations from sell-side analysts for earnings per share over the next four quarters, this only captures a small amount of the growth in the company's future. As a result, sometimes when trying to see if a growth stock is overpriced relative to its long-term business prospects, one can look at the 5-year PEG ratio. A PEG of less than 1 indicates that the company's earnings per share are expected to grow quickly compared to its current stock price.
Using data from Fidelity, here are ten stocks with a market capitalization of at least $2 billion with a trailing P/E greater than 20, but a 5-year PEG of less than 1:
P/E (trailing ttm)
Carpenter Technology (CRS)
IPG Photonics (IPGP)
Laredo Petroleum (LPI)
Southwest Airlines (LUV)
Dresser-Rand Group (DRC)
Transdigm Group (TDG)
Cubist Pharmaceuticals (CBST)
Ocwen Financial (OCN)
Ocwen is one of the most attractive-looking stocks on this list when judged by its growth prospects. The company services residential and commercial loans with a focus on subprime mortgage securities. It also invests in subprime mortgage loans. Clearly, this industry is not in good favor with investors, though Ocwen's stock has risen 36% so far in 2012. Leon Cooperman's Omega Advisors initiated a 4.8 million share position in the first quarter of the year, and billionaire Steve Cohen's SAC Capital Advisors was also an investor.
Laredo Petroleum is an oil and gas exploration and production company in the mid-Continent region of the U.S., primarily in the Permian Basin. It is a recent IPO that in its most recent quarter reported a 40% increase in revenue and a large increase in earnings compared to the same period in the previous year, putting it on track for a forward P/E of only 16. If analysts are correct in their optimism, then the stock could do well in the future. Investors should be warned that the company has missed analyst expectations in both quarters that it has been public.
We asked if Southwest is a good stock to buy last week, and noted D.E. Shaw's investment in the airline. While the company is exposed to macroeconomic risks as well as oil prices and is seeing increased competition from other budget, no-frills airlines, sell-side analysts are confident that its brand and pricing strategy will win out among consumers. As a result, they project high earnings growth over the next several years. Southwest also should be noted for trading at the book value of its equity.
Also in an aircraft-related business is Transdigm Group, which provides components for commercial and military aircraft. Surprisingly, given its industry, the company is not dependent on overall economic conditions with a beta of slightly less than 1. Transdigm is up 31% so far this year on the strength of beating earnings estimate three quarters in a row by at least 10%, and given that analyst projections currently place it as a good value compared to its future earnings, it has the possibility of increasing further in price if it can beat those expectations as well. Transdigm is a hedge fund favorite with Lone Pine Capital, managed by Tiger Cub Stephen Mandel, leading a group of several funds that reported at least $100 million of the stock in their 13F portfolios for the first quarter.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.