Finally, Dollar Tree, Inc. (NASDAQ:DLTR), is a great example of why the PEG ratio is so important. On the surface, with a PE of 18, the company might not seem like a value. While Dollar Tree, Inc. (NASDAQ:DLTR)’s stock may have doubled over the past two years, but its PEG is still just 0.98.
It’s a good example of why investors needn’t be overly focused on a P/E ratio. If a stock has a P/E of 9 and a PEG ratio of 2, it’s a far worse value than Dollar Tree, because its PE is trending upward to 18. Dollar Tree’s growth rate is, at the moment, higher than its lofty P/E, which is all that matters. This companies P/E should trend lower in the future, due to growth, a very bullish sign.
Beyond the numbers, Dollar Tree’s story makes sense. This discount retailer has thrived in good markets, but also in bad ones because its thrifty prices helps penny pinched customers. That fact makes it all the more impressive that the company has earned a return on equity of 39.84% just this past year.
Unlike the other stocks we’ve named, Dollar Tree is a stable play in all market conditions, yet it’s still expected to grow in the double digits. It may not seem like a sexy business, and it may not look (on the surface) particularly cheap, but it’s a classic Warren Buffett type stock, a great business at a fair price.
I think the Dollar Tree would work well with the other stocks mentioned, as a calming influence. You know what you’re going to get with it, and it carries very little headline risk.
Keeping it simple
I like these metrics, because they get to the heart of what makes for quality investments and quality stocks. PEG is not a perfect metric because it relies on growth estimates, but it’s still the most practical way to measure value relative to growth. Return on equity, like return on capital, is an essential metric as it shows investors how profitable a business is, and sheds like on the quality of a businesses earnings.
These metrics combine both Peter Lynch’s PEG ratio with elements of Joel Greenblatt’s magic formula. They’re widely available, easy to understand, and if used regularly, should lead you to good stocks.
Adem Tahiri owns shares of Apple. The Motley Fool recommends Apple and Ford. The Motley Fool owns shares of Apple and Ford.
The article Pick Great Value Stocks With 2 Easy Steps originally appeared on Fool.com and is written by Adem Tahiri.
Adem is a member of The Motley Fool Blog Network — entries represent the personal opinion of the blogger and are not formally edited.
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