PEGY With A Value Twist

By Will Ashworth | July 02, 2008 AAA

GARP investors use the PEG ratio to find good companies to buy that are simultaneously growth and value stocks. The PEG ratio divides price to earnings (P/E), usually an indication of a stock's value or lack thereof, by the five-year projected growth rate for earnings. Professional investors like Peter Lynch felt this blended approach was the best way to find possible "tenbaggers" - stocks that increase by 10 times the purchase price. Though difficult to find, these stocks have the potential to greatly increase your overall returns.

The system works great for small and mid-sized companies, but if you're an investor who wants to add larger companies to the mix, allow me to introduce you to PEGY - the PEGY ratio to be precise.

What PEGY Can Do for You
The PEGY ratio calculation is just like the PEG except that you add the dividend yield to the denominator. For example, a company whose current P/E is 15 and five-year projected earnings per share growth rate is 10%, has a PEG ratio of 1.5. However, that same company with a dividend yield of 5% has a PEGY ratio of 1, making it a more attractive investment.

Investor's wanting to rest easy about overpaying can take the PEGY and add price to sales. The additional value screen will provide a margin of safety most GARP investors can live with. For illustration purposes, our screen will select those stocks with the lowest price-to-sales ratio and a PEG below 1. The PEGY with a value twist is a ten-stock portfolio with two micro caps, three small caps, three mid caps, and two large caps. (To read about valuing companies based on the PEG ratio, see Move Over P/E, Make Way For The PEG.)

PEGY Ratio With A Value Twist


Company Market Cap PEG Yield (%) P/S
QC Holdings
(Nasdaq:QCCO)
133.7M 0.46 2.7 0.59
Cascade Financial
(Nasdaq:CASB)
84.2M 0.67 5.2 0.74
Christopher & Banks
(NYSE:CBK)
311M 0.77 2.7 0.53
Knoll
(NYSE:KNL)
603.7M 0.68 3.9 0.56
Boyd Gaming
(NYSE:BYD)
1.1B 0.38 4.7 0.57
Autoliv
(NYSE:ALV)
3.4B 0.93 3.3 0.50
Timken
(NYSE:TKR)
3.2B 0.90 2.1 0.59
Limited
(NYSE:LTD)
5.8B 0.99 3.5 0.60
Target
(NYSE:TGT)
3.8B 0.95 1.2 0.61
Metlife
(NYSE:MET)
3.9B 0.86 1.4 0.73
Data as of June 27, 2008.

QC Holdings (Nasdaq:QCCO)
Specializing in payday loans, this Kansas-based company has 588 branches in 25 states. It's customers are "middle Americans". A typical client has children, is under the age of 45 and has an annual income greater than $25,000.

Revenue and profit has grown nicely the last couple of years, yet its stock is down 44% in the last year. A major reason for this is the regulatory clampdown sweeping the nation. Payday lenders like QC Holdings and Advance America Cash Advance Centers (NYSE:AEA) are in danger of losing their premium interest rates and fees. Ohio passed legislation in early June capping the annual percentage rate at 28%, compared to current rates as high as 400% on an annual basis. Democratic presidential nominee Barack Obama is pressing for a 36% cap across the country. The company's latest 10-Q shows an average loan of $371, an average fee of $54 and an average term of 16 days. On a yearly basis, this works out to 375% interest. I think you can see the risk its stock presents. There is little chance it could survive with one-tenth its current revenue. A competitor, Cash America International (NYSE: CSH), announced will shut 139 stores in Ohio. Could QC be far behind? (To learn more, check out Payday Loans Don't Pay.)

Christopher & Banks (NYSE:CBK)
The Minnesota-based women's retailer has more than 800 stores in 48 states across three brands: Christopher & Banks, C.J. Banks and Acorn. There was both good news and bad in its first quarter report ended May 31, 2008. Earnings per share were 31 cents, five cents better than analyst expectations of 26 cents. Unfortunately, the second quarter won't be nearly as rosy.

Same-store sales are expected drop in the high single-digit range and EPS will be between 3 cents and flat, off substantially from the 11 cents per share analysts expected. Not surprisingly, the stock is dropping, trading at a five-year low, down 59% in the last 12 months alone. It had $91.5 million in cash at the end of May. That's approximately $2.60 per share. Taking into account a 20% drop in the stock price on June 27, it's currently trading at less than three times enterprise value, which compares favorably with competitors Ann Taylor (NYSE:ANN), Talbots (NYSE:TLB) and Charming Shoppes (Nasdaq:CHRS). Christopher & Banks could be moving from GARP stock to a straight value play.

Conclusion
The PEGY ratio is perfect for those GARP investors also interested in receiving dividend income. While less likely to produce tenbaggers, it should generate better-than-average total returns. For those with a value bent, adding a low price-to-sales ratio to the PEG ratio and dividend yield provides a more than adequate margin of safety.

For more on valuation ratios read the comprehensive Financial Ratio Tutorial.

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