While the price-to-earnings multiple is a common value metric, one drawback is that it does not account for future earnings growth. A way to correct for this is to use the PEG ratio, which includes both the P/E multiple and analyst expectations for future growth, although in turn there is often a good deal of inaccuracy in analyst forecasts. We track quarterly 13F filings from hundreds of hedge funds such as billionaire Steve Cohen’s SAC Capital Advisors as part of our work researching investment strategies (we have found, for example, 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 also like to screen filings from top managers according to a number of criteria. Read on for our quick take on SAC’s five largest holdings from the end of March with five-year PEG ratios less than 1 (or see the full list of Cohen’s stock picks).
The fund more than doubled the size of its position in SM Energy Co. (NYSE:SM), a $4.1 billion market cap oil and gas exploration and production company focused on U.S. share plays, to a total of 3.1 million shares. While revenue grew by 30% in the first quarter of 2013 versus a year earlier, SM’s quarterly report showed a significant decline in net income over the same period. Still, Wall Street analysts expect earnings per share to grow in 2014 placing the current valuation at 16 times forward earnings estimates.
SAC disclosed ownership of 4.3 million shares of GNC Holdings Inc (NYSE:GNC) as of the beginning of April. At a market capitalization of $4.5 billion, the drug store carries trailing and forward P/E multiples of 19 and 14, respectively; analysts then expect further improvements on the bottom line resulting in a PEG ratio below 1. While recent results have been decent, a number of market players are bearish on GNC: the most recent data shows that 12% of the float is held short. Still, we think GNC could qualify for “growth at a reasonable price” status.
Auto parts manufacturer Visteon Corp (NYSE:VC) was another of Cohen’s high upside potential picks; his fund owned 2.6 million shares per the filing, and the five-year PEG ratio is 0.8. This is due to general analyst optimism on many auto related industries- with a trailing P/E of 17, Visteon is certainly not a pure value play. While many bulls argue that U.S. consumers will soon have to buy new cars to replace an aging auto fleet, we just don’t think recent numbers have been good enough to recommend buying the stock.
According to the 13F, SAC increased its stake in offshore driller Transocean LTD (NYSE:RIG) to a total of 2.6 million shares by the end of Q1.Transocean is another stock where analysts are more optimistic than the market: consensus forecasts for next year imply a forward P/E of only 8, though those forecasts do include an expectation of considerably higher earnings per share in 2014 than for this year. Billionaire activist Carl Icahn has been pushing the company to return more cash to shareholders, which could result in a competitive yield for the stock.
Transocean does seem like an interesting company, but given how strongly its value status depends on improving its earnings while recent performance has not been so strong we think it is best placed on a watchlist for now. GNC and Michael Kors look interesting, in that while both have moderate to high earnings multiples they at least currently join those characteristics with enough earnings growth that the stocks could be quite appealing if those trends continue. We think either of the two could be worthy of further research.
Disclosure: I own no shares of any stocks mentioned in this article.
