A Winning Formula for Picking Stocks

August 4, 2023

What’s better… value or growth?

Many investors, hungry for big returns, say growth.

Today I’m going to show you why that’s wrong… and what you should look for instead.

Here’s the problem… Too many investors have grown comfortable with sky-high valuations and end up overpaying for their stocks.

This has led to the unappealing valuations we’re seeing in the market now.

For proof of this, take a look at the Buffett Indicator. It’s a simple metric… the total value of corporate equities divided by GDP. Created by the legendary Oracle of Omaha himself, it’s an effective predictor of long-term stock market returns.

Based on this measure, stocks are more expensive today than they were at the height of the dot-com bubble. And this is after valuations fell from their peak during last year’s bear market.

Few investors seem to be concerned. But paying too much for an investment increases risk and decreases reward potential.

You should be looking to do the opposite.

Now… many folks also think value investing means buying cheap stocks.

If the stock’s cheap, buy it!

Sorry… but that’s not right, either.

In fact, even Buffett, renowned for his value approach, doesn’t think in such simplistic terms. After all, he was influenced by two great investors and thinkers.

The first was Benjamin Graham, who was Buffett’s personal mentor, as well as the founder of the value school of investing. And the second was Philip Fisher – one of the biggest advocates of growth investing since the late 1950s.

In other words, both value and growth investing strategies have contributed to Buffett’s remarkable success.

Of course, he’s not alone…

Peter Lynch, another legendary investor, also believed in combining value and growth strategies. After over a decade of success, he published a book called One Up on Wall Street, in which he revealed his secret sauce, including a powerful tool he used for choosing stocks…

The PEG ratio.

This metric measures a company’s P/E ratio per share in relation to its expected annual earnings growth rate. Traditionally, a PEG ratio below 1.0 indicates the stock is potentially undervalued… while a ratio above 1.0 suggests the stock could be overvalued.

The PEG ratio provides a quick way to zero in on stocks trading at favorable prices relative to their growth potential.

But how well does it pinpoint high-performing stocks?

I ran a backtest on low-PEG stocks with market caps between $50 million and $300 million. I focused on microcaps due to the immense long-term growth potential they have compared with their larger peers.

The results were impressive…

Low-PEG microcaps outperformed the broad market by more than 160% and delivered a remarkable 970% return (around 26% annually) during this period.

This proves that value still plays a significant role in choosing the right stocks. Alongside a company’s growth potential, it forms a powerful, winning combination.

So why ask “Value or growth?”

I say value and growth.