Low PEG Ratios and High Dividend Yields
T-Mobile (DTEGY) & Fortress Investment (FIG)
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Fundamental Analysis 101
A sure-fire method to find stocks to invest in which will outperform the stock market during the next year or two, is to ferret out stocks with low PEG ratios and generous dividend yields. Many of you know how to calculate PEG ratios, but if you need to review the several ways to compute this important ratio, click HERE to find my guide to refresh your memory.
Calculate PEG Ratios and Become an Intelligent Investor
I prefer to determine PEG ratios using the following method because my method brings the dividend into the equation. First, let’s look at the components. The inputs are simple: the current stock price of a company (P), the latest four quarters of earnings per share (EPS), an estimate of how fast earnings per share will grow during the next five years (G) and lastly, the latest annual dividend yield.
Next, you can calculate the price to earnings ratio (P/E) by dividing the current stock price (P) by the latest four quarters of earnings per share. Then multiply the latest quarterly dividend by four to convert the quarterly amount to the annual dividend. Then divide the annual dividend by the current price (P) to derive the annual dividend yield (D). Finally, divide the P/E ratio by the combined Growth and Dividend Yield to determine the PEG ratio.
If you are using a computer spreadsheet, use the following formula to compute the PEG ratio:
PEG Ratio = SUM(P/E)/SUM(G+D)
Many investors do not include the dividend yield in the PEG ratio, but I believe my calculation is an excellent method to compare companies paying higher than average dividends. I like to think PEG ratios which include yields are used by the most intelligent investors!
How to find High-Quality Companies
In addition to low PEG ratios (below 1.00), I look for good quality companies with a history of steady earnings and dividends growth. Quality companies may not be extreme bargains, but high-quality companies will likely produce reliable dividend income and price appreciation.
A very simple measure can be used to determine which companies are high-quality and have produced steady earnings and dividend performance during the past 5 to 10 years. Standard & Poor’s evaluates most stocks and assigns a ranking called the S&P Quality Ranking.
Companies with A+, A, and A- S&P rankings indicate high-quality. I generally like to find companies with these rankings, although I will often include a company with a B+ ranking or occasionally a B ranking, if I believe the company has exceptional prospects. S&P rankings are usually provided on your broker’s website. Just go to the stock research tab and enter S&P in the search box.
In my February 11, 2013 Cabot Wealth Advisory, I recommended buying Microsoft (MSFT) and Prudential Financial (PRU) which had low PEG ratios. My recommendations have performed very well during the past four months despite the recent drop in the stock market. MSFT has climbed 19% and PRU is up 25% compared to a lesser gain of 5% for the Standard & Poor’s 500 Index.
High-quality stocks with low PEG ratios have consistently outperformed the stock market indexes in both advancing and declining markets. Investing in quality stocks at bargain prices makes sense in any stock market environment.
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Two good examples of companies with low PEG ratios are Deutsche Telekom AG (DTEGY) and Fortress Investment Group (FIG). The companies’ PEG ratios are less than 1.00, and DTEGY and FIG pay dividends yielding more than 3.5% which is an exceptional yield.
Deutsche Telekom AG (DTEGY: 11.35), based in Bonn, Germany, is Europe's largest communications company and one of the largest communications carriers worldwide. Deutsche Telekom offers a complete range of voice telephony products and services to its customers.
Through T-Mobile, Deutsche Telekom's mobile telephony subsidiary, and through other subsidiaries and investments, the company serves mobile telephony customers worldwide. Its major markets include Germany (57% of sales), the U.S. (24%) and other Europe (24%).
Sales increased just 1% and EPS dipped 12% during the past 12 months ended 3/31/13. Weak demand at T-Mobile USA and soft revenues from landlines in Germany hurt results. However, sales will likely increase 3% and EPS will jump 25% during the next 12 months ending 3/31/14. T-Mobile recently gained approval to sell iPhones for the first time. T-Mobile is also in the process of purchasing MetroPCS, which will greatly improve Deutsche Telekom's position in the U.S.
With a P/E of 15.1, expected EPS growth of 11.0%, and with a low PEG ratio of 0.80, DTEGY shares are clearly undervalued. The dividend yield is 7.8%, which is very attractive and well supported by more than $4.00 per share of cash flow. Shares are medium risk, but have low volatility.
Fortress Investment Group (FIG: 6.67) is a leading global alternative asset manager with $34 billion in assets under management as of March 31, 2008. Fortress is headquartered in New York City and has affiliates with offices in major cities around the world.
Fortress raises, invests and manages private equity funds and hedge funds. Fortress intends to grow its existing businesses by continuing to create innovative products to meet the increasing demand by sophisticated investors for superior risk-adjusted investment returns.
Revenues jumped 25% and EPS soared 75% during the 12 months ended 3/31/13. Assets under management received a big boost from stock market returns and from substantial additions to its private equity funds. Fund investments appreciated 30% from a year ago, which helped fuel 30% growth in capital inflows. Revenues will likely rise another 5% and EPS will advance 24% during the 12 months ending 3/31/14. Fortress’s stellar investment returns will attract additional capital during the next several quarters.
At 11.0 times current EPS and with a low PEG ratio of 0.65, FIG shares are undervalued. The dividend yield is 3.4%, which is attractive. Fortress Investment is high risk, though, because of wide swings in its share price.
Until next time, be kind and friendly to everyone you meet.
Editor of Cabot Benjamin Graham Value Letter
Editor's Note: You can read more about PEG Ratio analysis and Benjamin Graham and get continuing coverage of Deutsche Telekom and Fortress in the Cabot Benjamin Graham Value Investor. There you'll not only find buy and sell advice for Deutsche Telekom and Fortress, you'll get 20 other excellent value stock recommendations from J. Royden Ward each and every month. Roy applies the strategy of the father of value investing, Benjamin Graham, to find the market's best undervalued stocks. And he will tell you exactly when to sell. Don't miss out on his next recommendations ...