One way to measure a stock’s upside potential is with the PEG ratio; though this metric is dependent on analyst expectations for future earnings growth, it is at least one way to combine growth prospects with the P/E multiple in a quantitative way. At the very least stocks with low PEG ratios can be treated as free investment ideas requiring further research before making a decision. We track quarterly 13F filings from hedge funds 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 18 percentage points per year on average) and so can also see which stocks top managers liked which are attractive according to the PEG metric. Here are five stocks which billionaire and Tiger Cub Stephen Mandel’s Lone Pine Capital had over $200 million invested in at the end of December and which have five-year PEG ratios less than 1 (or see the full list of stocks Lone Pine reported owning):
The fund increased its stake in Dollar General Corp. (NYSE:DG) by 61%, making the dollar store one of the five largest holdings by market value in its 13F portfolio. Dollar General’s revenue was up 10% last quarter compared to the fourth quarter of 2011, and earnings grew at a 21% rate; expectations of continued growth, combined with the trailing earnings multiple of 19, make for a stock with at least some upside potential. Eton Park Capital, managed by Eric Mindich, was also buying Dollar General last quarter and closed December with 6.5 million shares in its portfolio (find Mindich’s favorite stocks).
Upscale apparel and accessories company Michael Kors Holdings Ltd (NYSE:KORS) was another of Mandel’s top picks. While the stock is expensive in terms of trailing earnings with a P/E of 32, Wall Street analysts are quite optimistic about earnings growth for the next several years and as a result the PEG ratio is 0.9. Indeed, revenue grew 70% in Michael Kors’ most recent quarter compared to the same period in the previous year. We’d note that Kors has a beta of 2.9, meaning that its stock price is very sensitive to market conditions.
See three more stocks Mandel liked:
Lone Pine disclosed ownership of 5.9 million shares of Wyndham Worldwide Corporation (NYSE:WYN) as of the end of 2012, roughly even with what it had owned three months earlier. The hotel and vacation ownership company is another one where investors are depending on substantial bottom-line growth: the stock carries trailing and forward P/Es of 23 and 15, respectively. Iridian Asset Management, run by David Cohen and Harold Levy, was another major shareholder of Wyndham according to its own 13F (check out Iridian’s stock picks).
Mandel and his team initiated a position of 4.4 million shares in Capital One Financial Corp. (NYSE:COF) between October and December. Capital One, unlike the companies we’ve discussed thus far, qualifies for value status at a trailing P/E of only 9. At that pricing, it only needs to keep its business steady to weakly growing in order to prove undervalued. It also trades at a discount to the book value of its equity. Last quarter fellow Tiger Cub Andreas Halvorsen’s Viking Global increased its own holdings of Capital One to nearly 14 million shares (research more stocks Halvorsen was buying).
WABCO Holdings Inc. (NYSE:WBC) rounds out our list of Mandel’s picks with high upside potential as the $4.5 billion auto parts manufacturer boasts a five-year PEG ratio of 0.8. It’s another company with significant macro exposure, as shown by the beta of 2.3. Analysts are generally bullish on companies tied to autos, and WABCO in fact trades at a premium to many automakers and auto parts manufacturers in terms of its trailing earnings. Warren Buffett and Berkshire Hathaway were buying the stock last quarter (see more stocks that Buffett likes).
Disclosure: I own no shares of any stocks mentioned in this article.