PEG 5: Great Returns without the Ulcers!
by Moe Chernick (firstname.lastname@example.org)
El Segundo, CA (July 20, 1999) -- The PEG 5, which I introduced in my last report, is a growth strategy with a value element added to enhance returns and minimize risk.
The PEG 5 strategy works well using almost any time period and therefore can be traded as little as once a year -- a real advantage if you are using the strategy in taxable accounts. The CAGR for a 12-month hold version of the PEG 5 is 41% since January 1987.
For those of you with Value Line, the steps to run the screen are shown below. If you don't have Value Line, no problem. The current screen rankings can be obtained each week (updated on Fridays) by clicking on the New Rankings link here and at the bottom of each Workshop Report. Even if you use our rankings, though, you should understand how the screen works, because that is the key to why it works.
First, set up a User Defined field (Tools menu) named PEG. Define it as Price/Earnings last 12 months divided by Projected EPS Growth Rate.
Step 1: Run a filter (Tools menu) that selects only stocks with a Value Line Timeliness Rating less than or equal to 2 and a "Price/Earnings Last 12 Months" value greater than 0.
Step 2: Sort the stocks that pass this filter in descending order by 26-week total return. Tag the top 25 stocks and select "Show only tagged" (View menu) to drop the rest of the list.
Step 3: Sort the top 25 stocks in descending order by Projected EPS Growth Rate. Click the tag marks on stocks 11-25 to clear them away.
Step 4: Sort the remaining 10 stocks in ascending order by PEG.
Step 5: Buy the top 5 stocks
This screen works in three stages. Stage 1, the first 2 steps listed above, gives us 25 high-quality stocks with strong relative strength.
Stage 2, step 3 above, is what gets us smoking. In this step, we reduce the list of 25 high-quality stocks to the 10 stocks that Value Line projects will grow earnings the most in the future. At this stage, the screen has 10 high-quality stocks with strong relative strength and high projected EPS (earnings per share) growth. When checking these stocks on your own, remember that Value Line's projected growth rate is not the same as the consensus estimated growth estimates that you will find on many websites, including this one.
Stage 3, step 4 above, is the Maalox Eliminator. It adds a bit of old-fashioned value to the stock selection process. If a stock is screaming along and its price has already gone through the roof, this screen says no thanks. The PEG ratio ensures that the stocks we buy are still relative bargains. Actually, it goes right back to basic Foolishness. The importance of the PEG is described in the Motley Fool Investment Guide and online in Step 10 of the Fool's School introductory course: 13 Steps to Investing Foolishly.
Does it work? Since 1987 it has worked better than any screen here at the Workshop. The five-stock version of PEG with an annual holding period starting in January has a CAGR of 41.6%, with 1998 being the only losing year.
The five-stock semiannual version of PEG (buying every January and every July and holding for six months) has even better returns, with a CAGR of 48.6% and no losing years.
How is PEG doing this year? Very nicely, thank you. At the midway point of the year (July 2), the PEG 5 was up a smashing 42.7%. Click the 1999 Returns link below to see how it is doing through last Friday.