2 great stocks PEG-ged for value

Finding great long-term investments is easy, if you've done huge amounts of groundwork and study. But there are some short cuts.

By MoneyShow.com Feb 1, 2012 2:09PM

Image: Arrow Up (© moodboard/Corbis)By J. Royden Ward, Cabot Benjamin Graham Value Letter


How can you adapt what I have learned during the past several decades and create your own simplified investment approach? 


Very easy. I can get you on your way to steady, above-average profits using just two metrics: the Standard & Poor's Quality Ranking and the PEG ratio.


First, look for good quality companies with a history of steady earnings and dividends growth. Quality companies may not be extreme bargains, but high-quality companies will likely produce dividend income and price appreciation upon which you can rely.


There is a very simple measure to determine which companies are high quality and have produced steady earnings and dividend performance during the past five to ten years. Standard & Poor's evaluates most stocks and assigns a ranking called the S&P Quality Ranking.


Companies with A+, A, and A- S&P rankings indicate high quality. I generally like to find companies with these rankings, although I will often include a company with a B+ ranking or occasionally a B, if I believe the company has exceptional prospects.


S&P rankings are usually provided on your broker's website. Just go to the stock research tab and enter S&P in the search box.


In addition to a high S&P Quality Ranking, I recommend using the PEG ratio to measure the degree to which a stock is undervalued. I use the ratio to find stocks selling at reasonable prices.


The PEG (price/earnings to growth) ratio is calculated by dividing the P/E (price to earnings) ratio by the earnings growth rate. Comparing PEG ratios will provide a good measure of which stocks are undervalued and selling at bargain prices.


The price used in the P/E ratio is the stock's recent price. Earnings consist of estimated EPS (earnings per share) for the next 12 months. The growth rate (the "G" in the PEG ratio) is the estimated rate of EPS growth for the next five years.


A PEG ratio of less than one indicates that a stock is undervalued. The lowest PEG ratios are best.


Two good examples of high-quality companies with low PEG ratios are FedEx (FDX) and Universal Health (UHS). Both companies have S&P Quality Rankings of B or better and PEG ratios of less than one, meeting my objectives.


FedEx 
Standard & Poor's Quality Ranking for FedEx is B+, which indicates the company has produced steady earnings and dividend performance during the past five to 10 years. My calculation of FedEx's PEG ratio of 0.85 is based upon the current stock price of $91.12, my forward 12-month earnings per share estimate of $6.54, and my estimated five-year earnings per share growth rate of 16.5%.


FDX provides worldwide on-time air express delivery for packages and freight in 220 countries, and door-to-door delivery of small packages in North America. The company also operates 1,200 copy centers (formerly Kinkos), which offer various business services.


Growth in the package shipping business is accelerating due to a rise in online shopping. The surge in demand has allowed FedEx to boost freight rates by 6.7% in September 2011 and another 5.9% in January 2012.


Most importantly, the US Postal Service (USPS), FedEx's competitor, will cut costs and services beginning in 2012 to balance its budget. USPS estimates most deliveries will take two to three days within the U.S., rather than the current one- to two-day delivery. Customers will likely rely more heavily on FedEx and UPS to handle important deliveries.


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 19% and EPS by 14% during the next 12 months. The company also pays a small dividend.


Universal Health 

Standard & Poor's Quality Ranking for UHS is B+, which is a reflection of the company's strong balance sheet and steady earnings and dividend performance during the past 10 years. My calculation of UHS's PEG ratio of 0.76 is based upon the current stock price of $41.45, my forward 12-month earnings per share estimate of $4.33, and my estimated five-year earnings per share growth rate of 12.7%.


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 at Universal Health. In addition, the acquisition allows a better balance between acute care and behavioral health. Psychiatric Solutions has produced rapid growth, high occupancy rates, longer stays, and considerably lower uncompensated care.


Universal is expanding its outpatient services to help reduce health-care costs for patients. The company is also implementing efficiency programs to improve financial performance while enhancing patient satisfaction and outcomes.


We expect sales and earnings to increase 10% and 14% respectively during the next 12 months. UHS pays a small dividend, and the PEG ratio of 0.76 is very reasonable.


Subscribe to Cabot Benjamin Graham Value Letter here.


Related Reading:

Investing Long Term? Start with These 4

Brother, Can You Spare a Backhoe?

The Next Tech Stock to Offer a Dividend?

Tags: FDX
0Comments

DATA PROVIDERS

Copyright © 2014 Microsoft. All rights reserved.

Fundamental company data and historical chart data provided by Morningstar Inc. Real-time index quotes and delayed quotes supplied by Morningstar Inc. Quotes delayed by up to 15 minutes, except where indicated otherwise. Fund summary, fund performance and dividend data provided by Morningstar Inc. Analyst recommendations provided by Zacks Investment Research. StockScouter data provided by Verus Analytics. IPO data provided by Hoover's Inc. Index membership data provided by Morningstar Inc.

STOCK SCOUTER

StockScouter rates stocks from 1 to 10, with 10 being the best, using a system of advanced mathematics to determine a stock's expected risk and return. Ratings are displayed on a bell curve, meaning there will be fewer ratings of 1 and 10 and far more of 4 through 7.

123
123 rated 1
262
262 rated 2
480
480 rated 3
651
651 rated 4
649
649 rated 5
629
629 rated 6
616
616 rated 7
496
496 rated 8
346
346 rated 9
111
111 rated 10
12345678910

Top Picks

SYMBOLNAMERATING
EXCEXELON CORPORATION9
TAT&T Inc9
VZVERIZON COMMUNICATIONS8
CTLCENTURYLINK Inc8
AAPLAPPLE Inc10
More

VIDEO ON MSN MONEY

ABOUT

Top Stocks provides analysis about the most noteworthy stocks in the market each day, combining some of the best content from around the MSN Money site and the rest of the Web.

Contributors include professional investors and journalists affiliated with MSN Money.

Follow us on Twitter @topstocksmsn.