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.
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.
According to the filing, Mandel had 5.5 million shares of hotel and vacation home operator Wyndham Worldwide Corporation (NYSE:WYN). The stock carries trailing and forward earnings multiples of 22 and 14, respectively, demonstrating that the sell-side is forecasting significant improvements in earnings per share over the next year and a half. While Wyndham has been reporting higher revenue, its last quarterly report showed reduced margins and therefore lower net income last quarter compared to the first quarter of 2012. As a result we wouldn’t be too excited about the stock right now.
Lone Pine reported a position of 4.8 million shares in B/E Aerospace Inc (NASDAQ:BEAV), a $6.9 billion market cap provider of aircraft components; this was about even with what the fund had owned at the beginning of the year. While recent numbers have been good, B/E Aerospace is another company which is dependent on high growth going forward- it is currently valued at 27 times its trailing earnings. While analyst expectations are high enough to imply a five-year PEG ratio of 0.8, we’d be somewhat skeptical.
QUALCOMM, Inc. (NASDAQ:QCOM) and Cognizant seem somewhat interesting, in the sense that their valuations are only moderately high and the projections from analysts can be partially justified by what the companies have actually been doing. Kors is certainly an expensive stock, but that is in line with the higher recent growth at that company (and in turn high expectations for the future).
Disclosure: I own no shares of any stocks mentioned in this article.
