Most of the time, value investors look for stocks that have a price-to-earnings (P/E) ratio that is less than the PEG ratio below 1. For example, a stock with a P/E of 15 and an earnings growth rate of 20% would get a PEG ratio of 0.75 (15/20).growth rate, or a
But these are not normal times. Right now, there are a group of stocks in the S&P 500 with a PEG ratio below 0.5. I've rarely seen that in my 19 years of investing. You may not be ready to wade into this scary market just yet, but when you do, check out these stocks. They are trading for once-in-a-generation lows in terms of their PEG ratios.
Five stocks in particular have caught my eye. I've written about some of them in recent months, and they all have bright futures ahead of them once investors start to look down the road.
The recent market swoon appears to imply the U.S. and European economies are headed for a deep and prolonged recession. Yet economists aren't actually calling for that, instead simply anticipating very little growth in the United States and Europe. More tellingly, the global is likely to do OK in 2012 thanks to dynamic emerging economies. The International Monetary Fund (IMF) recently predicted the global economy would grow 4% in 2012 -- even after accounting for all of the current headwinds in place.
When investors do return to bank stocks, they'll seek out the best-run institutions. For example, Wells Fargo (NYSE: WFC), a favorite stock of Warren Buffett, is back to trading levels seen back in 2004. The bank is far larger and vastly more profitable compared to seven years ago, and looks too cheap to ignore, trading at seven times projected 2012 profits. The PEG ratio: just 0.36.
If those IMF forecasters are correct -- that emerging economies such as Brazil, India and China are poised for continued economic expansion -- then you need to reconsider the prospects for Citigroup (NYSE: C), which has been steadily focusing its efforts in those areas since the 2008 crisis ended. The bank now derives more than half its revenue outside the United States. And its U.S. operations are in far better shape than a few years ago. Citigroup carries $138 billion in tangible book value, yet is valued at just $82 billion. That's quite a gap. The PEG ratio of just 0.31 is another way to say that this stock is just too cheap.
Nucor (NYSE: NUE)
The world's major steel producers surely carry risk. If demand drops, then pricing usually slumps as well, dealing a double whammy that can make some firms like U.S. Steel (NYSE: USX) unprofitable every few years. But the entire sector appears oversold, anticipating more gloom and doom than is warranted. This is the logic behind my recent bullish profile of industry leader Arcelor Mittal (NYSE: MT).
Yet if you believe a conservative approach is still warranted for this sector, then check out Nucor, which has always had a clever approach to labor costs. When business is good, its workforce gets bonuses. When business slumps, they receive less. This helps Nucor stay profitable in virtually any economic climate. In fact, the company has generated positive free cash flow for each of the past 10 years (which is as far back as my data goes). Even in 2009, when sales plunged 50% to $11.2 billion, Nucor still generated $340 million in free cash flow.
The PEG ratio for this stock is just 0.32.
Ingersoll-Rand (NYSE: IR)
As is the case with Wells Fargo, this industrial firm is also in Warren Buffett's portfolio. I recently took a deep look at the company, highlighting the company's vast streamlining efforts, which are expected to boost profits at a nice clip in the next few years. Even if analysts are wrong about the economy, and their projections of annual 5% to 7% sales growth for Ingersoll-Rand in the next two years is wrong, profits should at least stay flat, thanks to those cost-cutting efforts. If so, you would need to merely shift your analysis of the PEG ratio out another year or two, when the economy looks better. And besides, the PEG ratio for this stock is just 0.36.
Dean Foods (NYSE: DF)
This turnaround play is being overlooked by many investors. The food and beverage company had gone on a buying binge in the last decade, acquiring a range of dairy-related businesses. Those deals never coalesced into one profitable platform. Per share profits peaked in 2006 at $2, and fell by more than 75% by 2010. Part of the profit woe stemmed from the fact that supermarkets sought to attract customers by selling private-label milk at a loss.
Industry pricing has become rational again, and Dean Foods has been able to negotiate much better terms in revised contracts. Moreover, management has been steadily reducing both its own production costs as well as administrative overhead. Analysts at Merrill Lynch see EPS rebounding from $0.69 this year to $0.90 in 2012 -- a 30% jump. They upgraded their rating on the stock from "Neutral" to "Buy" on July 22 -- the day the market slump began.
Shares began to reflect that improving outlook earlier this summer, rising from $10 in April to almost $14 in June. Yet the market rout has pushed the stock right down to $8 in very short order. Merrill Lynch sees shares rebounding back to $13 when the company's earnings power comes back into evidence in coming quarters. The PEG ratio is just 0.43 for this stock.
Risks to consider: These stocks sport very low PEG ratios thanks to expectations of strong profit growth in 2012. If the economy does meaningfully shrink in 2012, then these forecasts will need to come down, PEG higher. However, in many instances, this would only mean that profit growth is flat -- but not negative -- pushing out the anticipated profit growth into the next year.
Action to Take --> The key catalyst for these stocks: A boring market that is no longer plunging. This would help assure investors that these already-cheap shares are not on the cusp of getting even cheaper. It's hard to imagine that happening, which is why many of these stocks should be considered very strongly for your portfolio.