One way to estimate a stock’s upside potential is by using the PEG ratio, which incorporates both the P/E multiple favored by value investors and analyst expectations for future earnings growth. While investors should take the PEG ratio with a grain of salt since analysts aren’t always accurate, it at least represents a quantitative screen which takes growth into account to some degree. We track quarterly 13F filings from hundreds of hedge funds including billionaire (and Tiger Cub) Stephen Mandel’s Lone Pine Capital as part of our work developing investment strategies (for example, we have found that the most popular small cap stocks among hedge funds outperform the S&P 500 by an average of 18 percentage points per year) and so can screen these managers’ picks for stocks with low PEG ratios. Here are Lone Pine’s five largest holdings as of the end of March with five-year PEG ratios of 0.9 or lower (or see the full list of Mandel’s stock picks):
The fund reduced its holdings of Cognizant Technology Solutions Corp (NASDAQ:CTSH) by 21% but still owned 8.7 million shares of the stock at the end of Q1. Cognizant is a $19 billion market cap IT related software and services company. In the first quarter of 2013, its revenue rose by 18% versus a year earlier, and with margins more or less holding steady the company’s net income grew by 17%. With a trailing earnings multiple in the high teens and Wall Street analysts projecting further growth, Cognizant ends up with a PEG ratio of 0.9.
Mandel and his team increased their stake in QUALCOMM, Inc. (NASDAQ:QCOM) to a total of 8.3 million shares. QUALCOMM, Inc. (NASDAQ:QCOM) has also been experiencing solid growth numbers, with revenue and pretax income up over 20% from their levels a year ago (net income is down, but that is due to significant earnings from discontinued operations in 2012). The stock trades at 18 times trailing earnings, and could well be a “growth at a reasonable price” stock. QUALCOMM, Inc. (NASDAQ:QCOM) had made our list of the ten most popular stocks among hedge funds in the first quarter of 2013 (find more of hedge funds’ favorite stocks).
Michael Kors Holdings Ltd(NYSE:KORS) was another of Lone Pine’s high upside potential picks with the 13F disclosing ownership of 8.1 million shares. Kors is almost entirely a growth play, with a trailing P/E of 31, and it’s highly dependent on the broader economy with a beta of 2.6. However, recent financial results have been strong as earnings more than doubled in its most recent quarter compared to the same period in the previous fiscal year. Despite the aggressive valuation it might be worth considering, or at least placing on a watchlist to track future performance.