Cheap stocks are great, but sometimes you get what you pay for. What's the use of a bargain-basement price-to-earnings ratio if the company can't grow? I have a long investment horizon and a high tolerance for risk, so I'm more interested in promising growth stocks than stodgy dividend machines.
To find stocks that satisfy my need for speed while also going on sale at a great price, I like to look at the PEG ratio. It's such a Foolishly useful metric that we've been known to call it the Fool Ratio. Divide the trailing P/E ratio of a stock by the estimated five-year earnings growth, and you have a neat little package representing the growth-adjusted value of the company. A fairly valued stock should land near the 1.0 mark. Higher numbers might indicate an overvalued security. A strong business with a low PEG ratio rocks!
InterDigital (Nasdaq: IDCC) is sporting a way-low PEG ratio of 0.5 today. The bottom line is expected to grow by about 15% a year over the next five years, and the stock is trading at a very low 7.5 times trailing earnings.
Here's how InterDigital stacks up against some of its closest competitors in the market for wireless communications research and development:
|
Company |
Trailing P/E Ratio |
5-Year Earnings CAGR Forecast |
PEG Ratio |
|---|---|---|---|
|
InterDigital |
7.5 |
15% |
0.5 |
|
Alcatel-Lucent (NYSE: ALU) |
N/A |
5% |
N/A |
|
Qualcomm (Nasdaq: QCOM) |
20 |
17% |
1.2 |
Source: Yahoo! Finance. CAGR = compound annual growth rate.
Many of today's smartphones, tablet computers, and other wireless gadgets depend on technology born at InterDigital over the past four decades. This is one of the truly unsung heroes of the wireless revolution.
The research-oriented company is turning a profit while many of its competitors can't and has profit margins to die for. This roughly billion-dollar small cap has $400 million of nearly debt-free cash in the bank. That ultrastrong balance sheet makes the stock look even cheaper than the already impressive PEG ratio. And it's not as if the world is swearing off wireless technology forevermore -- if anything, the wire-cutting has only just begun. InterDigital's best years may still lie ahead.
What to do next
As with all simple tools, the PEG ratio isn't a silver bullet to solve your portfolio's every quandary. It is, however, a great starting point for further research -- fellow Fool Joey Khattab has shown low-PEG stocks beating the market in a 1,000-ticker sample. With a very low PEG ratio backed up by a strong business, I'd say that you should get to know InterDigital a little better. This stock rocks!
