This article is part of our Rising Stars Portfolio series.
Now is a fantastic time to be a value investor, and it's an even better time to be a growth investor. Financial giants such as Buffett, Greenblatt, and Fisher did well buying growing companies for rock-bottom prices. These guys weren't just buying outrageously cheap stocks -- they bought growth potential for pennies on the dollar.
But how do you find them?
My favorite method for finding cheap growth stocks involves the PEG ratio. This metric tells you how much you are paying for the expected long-term growth. If a company has a PEG of 1, then for each point of growth, you're paying one times earnings. But if growth expectations are higher than the P/E, the PEG dips below 1, giving you more bang for your buck.
Now, the fun part
With that said, here are five cheap stocks with great growth potential that also earn positive ratings from our 170,000-plus-member Motley Fool CAPS community.
These stocks have:
- Forward P/Es less than 30.
- PEGs less than 0.8.
- Positive ratings (three, four, or five out of five stars) from our community of investors.
(out of 5)
|NorthStar Realty Finance (NYSE: NRF )
|Tata Motors (NYSE: TTM )
|Lloyds Banking Group (NYSE: LYG )
|E*TRADE Financial (NYSE: ETFC )
|China Green Agriculture (NYSE: CGA )
Data from Zacks Investment Research and Motley Fool CAPS.
Financial REITs such as NorthStar Realty Finance and RAIT Financial Trust have been able to take advantage of the low interest rate environment to borrow money, lend it at a higher rate, and pocket the profits. With QE2 taking effect and the Fed's keeping rates low, companies such as NorthStar and Chimera Investments should be able to continue earning large profits and passing them on as dividends.
Tata made a big splash three years back with the unveiling of its Nano, the $2,500 car meant for the average Indian consumer. The Nano hasn't been selling well this year over safety concerns. This is costly for the company as its reputation has been damaged, but it has also given time for competitors to come to market with new offerings. For instance, in December, Toyota introduced its new Etios subcompact into India. If Tata can get its safety woes behind it, I suspect many Indians will continue to support the idea of buying an Indian car, which would keep Tata's stock on its growth trajectory.
A tip of the CAPS
Each week, I cull a top stock idea from the pitches made on CAPS. Lloyds Banking group was a pick in October. To follow my weekly picks, you can subscribe to the series' RSS feed or follow it on Twitter.
E*TRADE's stock has risen over the past month from some speculation that E*TRADE will be involved in some sort of deal this year. Depending who your fortune-teller is, the company would make a great merger partner with AMERITRADE, or could by bought out by an even larger rival for anywhere from $20-$30 per share. While the company has had some woes the past few years, it is expected to grow as the market continues to surge forward.
CGA's stock has been crushed as general mistrust grew around Chinese small caps and floods hit China. China Green Agriculture makes organic fertilizers, a necessary product as Chinese farmers must increase their yield to keep up with a rising population and decreasing arable land. For this reason and more, the Chinese organic fertilizer market is expected to grow at over 30%.
The company has almost nationwide distribution, with a concentration in the central and northern Chinese markets. It recently started delivering its fertilizer as a concentrated powder, which should help margins and distribution. Global Gains advisor Tim Hanson has recommended China Green Agriculture since November 2008. Shares are up more than 250% since his recommendation (which includes the 40% drop this past year).
Even with recent allegations of fraud, the team wrote two weeks ago, "Although we admittedly can't have total knowledge of the inner workings of Chinese small caps like China Green (or any company, for that matter), our meetings with management and tours of the company's facilities leave us confident that long-term investors will benefit from staying cucumber-cool and taking advantage of the stock's recent dip to start or top up positions in the stock." For CGA's response to all the allegations click here for the detailed shareholder letter.
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