Jim Slater famously pioneered the PEG ratio as a way to look for undervalued shares with strong growth expectations. In today's market, there are quite a few candidates, and we pick out three.
The PEG ratio, popularised by Jim Slater, is formed by dividing a company's P/E ratio by its expected earnings per share growth, such that a company with a P/E of 9 whose EPS is expected to grow by 12% in the coming year will have a PEG of 9/12, or 0.75. Most growth investors tend to look for companies with a PEG ratio of 0.7, so that's what I went in search for, and here are three that caught my eye.
Autonomy still heading upwards
Data management and search pioneer Autonomy (LSE: AU) is a company that I have admired for some time. Since my last look at the company, a whole raft of new brokers' forecasts have been issued, pushing expectations for 2009 and 2010 upwards:
| Years ending 31 Dec | 2004 | 2005 | 2006 | 2007 | 2008 | (f)2009 | (f)2010 |
|---|
| Turnover (£m) | 34 | 56 | 128 | 173 | 344 | 496 | 606 |
| Pre-tax profit (£m) | 4 | 11 | 29 | 48 | 128 | 221 | 273 |
| EPS (p) | 2.6 | 6.6 | 11 | 16 | 42 | 68 | 81 |
The current price of 1,470p puts Autonomy's shares on a prospective P/E of approx 20, for a PEG of just under 0.5.
So, a good track record, two years of solid growth expectations, more than 10 brokers following the company (Brokers' forecasts are often not worth the electrons they're written on, so it's much better to see a large number of forecasts than just one or two), and a PEG well below 0.7. That sounds like heaven for PEG investors to me, and I'd be very surprised if the shares aren't significantly higher in a couple of years time.
An interesting diagnosis
On a PEG of just 0.2, I couldn't help noticing Axis-Shield (LSE: ASD), a company with a market cap of £140m and a share price of 299p. Axis-Shield develops medical diagnostic equipment and procedures, and news over the past year has suggested that the company's products are continuing to be successful. From a loss in 2004, the company has gone on to provide investors with positive, if erratic, earnings.
Normalised earnings came in at 6.2p per share for 2008, which was slightly up on 2007. But more interestingly, forecasts suggest EPS of 13.6p for 2009 and 22p for 2010, representing growth of 120% and 60% respectively. There are only 5 brokers currently forecasting for Axis-Shield, and one of those is the company's house broker Piper Jaffray, so that's not as solid as Autonomy. But then, the PEG is a lot lower too, so while there's more risk, there may well be more potential for a quick profit.
I certainly wouldn't invest just on this quick PEG analysis, but I think Axis-Shield is worth a closer look.
Aim for the sky?
Another intriguing possibility is a company I'd never heard of before today, the AIM-listed Aero Inventory (LSE: AI). With a market cap of £95m and a share price of 187p, it's not huge, but it's not a penny share tiddler either. But what struck me about it was its extremely low P/E of just over 2 and, with good forecasts for the next two years, a PEG of just 0.14. According to its web site:
"Aero Inventory is a service provider to companies in the aerospace industry, providing a comprehensive procurement and inventory management service.
We focus on the hundreds of thousands of consumable and expendable parts required in the maintenance of commercial aircraft and our e-based systems are complemented by on-site representation and 24-hour customer support."
The company apparently failed in negotiations with a major airline in March, following the raising of capital via a new share issue in February, but it does count Quantas and All Nippon Airways amongst its customers.
There are only three brokers forecasting. But with earnings per share of 76.5p, up 50%, expected in June 2009, and with 85.5p penciled in for 2010, is this a small company that is currently mispriced by the market? It's got to be worth a look.
Finally, a caution
My eye also fell upon a travel agent by the name of Travelzest (LSE: TVZ), with an apparently ludicrously low PEG of 0.07 and a P/E of 2.6. However, on closer inspection, a couple of weeks ago the company announced that chief executive Christopher Mottershead is being investigated over suspicions of misappropriation of company funds. The boss making off with the cash is certainly something that could put a dent in profit forecasts, which is a timely reminder that we really do need to check the words behind the numbers.
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