Valuing the price of stocks and their underlying businesses can be a daunting task. Investors have no shortage of available metrics: There's the price-to-earnings ratio, enterprise value-to-EBITDA, and the measure our own Sean Williams came up with: TMFULOI.
Below, I'll tell you about three companies that look very cheap according to one of my metrics of choice. I'll detail their businesses for you and then offer up a special free report on a few companies that could boom after this year's presidential elections.
Choose your measuring stick carefully
One metric that I personally like to keep an eye on is a company's P/E-to-growth ratio, or PEG ratio. Ostensibly, this metric attempts to take a company's current P/E and rate it against its predicted growth.
On paper, a perfectly priced stock should have a PEG of 1.0 -- meaning that future growth is adequately accounted for in a stock's price. Anything above that would be considered overvalued, while anything below is deemed undervalued.
The biggest concern about this ratio -- and it's a valid one -- is that it is based on the assumption that analysts can accurately predict the type of growth a company can expect years into the future. There is, of course, plenty of evidence showing that predicting the future is an infinitely difficult task.
In order to compensate for that handicap, I went looking for companies with a PEG ratio of less than one that had a history of consistently beating analyst expectations. Though it's not a perfect solution to negate the risks associated with valuing a stock based on future performance, I think it adds a margin of safety.
When all was said and done, I found three candidates in which I'm so confident that I'll be making the picks public on my All-Star CAPS portfolio.
What It Does
Consecutive Quarters of Beating Estimates
Baidu (NAS: BIDU)
Chinese Internet search engine
Portfolio Recovery Associates (NAS: PRAA)
SodaStream (NAS: SODA)
Makes homemade-soda machines
Source: Yahoo! Finance; E*TRADE. *Company has only had six reportable quarters as a publicly traded company.
Look past China slowdown concerns
Baidu has been beaten up lately because of concerns over slower growth in China. But even if growth is slowing, consider these two facts: Less than 40% of Chinese residents have regular access to the Internet, and last quarter each individual advertiser on the company's platform contributed 49% more revenue than last year. That means each advertiser is willing to pay Baidu more to host its ads, and that number should only go up as Internet adoption rates rise in China.
To be honest, if you're looking for international Internet plays, Yandex (NAS: YNDX) would be worth some investigation as well. The company -- which is primarily a search engine in Russia -- trades with a PEG ratio of just 0.63 and has met or beaten analyst estimates in its four quarters as a publicly traded company.
In the end, I end up leaning more toward Baidu because it's about seven times bigger than Yandex, and I'm more familiar with the prospects in China than I am with the Russian economy.
Getting paid to do the dirty work
Portfolio Recovery actually has a pretty simple business model. Say you have some customers you don't think will repay you. Their bills total about $1,000 -- but it's as good as nothing as far as you're concerned. If a company came along and offered you $100 for the right to collect the money, it might not seem like a bad deal. If that company is able to collect more than $100, then it turns out to be a good deal for it, too.
In a nutshell, this is what Portfolio Recovery does: It buys blocs of debt from institutions for pennies on the dollar, and then attempts to collect that debt. The key to success is paying the right price for the bloc of debt and knowing how to collect it.
The company has done a great job, but there have been some hiccups lately. First, Barron's recently reported that Portfolio Recovery was overstating its earnings -- to which the company responded by denying the report. There are also several lawsuits pending in different states regarding the methods by which these debts are collected.
I'll admit that it makes me queasy to think of investing with people whose job is to harass folks who are likely fighting to make ends meet. But I don't own the stock; I'm just saying on my CAPS profile that it's likely to outperform.
A recent convert
When it comes to SodaStream, I'll admit that I was recently hesitant about the company. Having not actually used its product, I didn't see how the company would have a future any different from that which has befallenGreen Mountain Coffee Roasters (NAS: GMCR) .
But having now purchased the machine, I can say that my wife and I are thoroughly impressed. And while I'll admit that there's no moat for protecting the company's flavor additives, it still has patents on its high-margin refillable carbonators. That's the type of patent protection Green Mountain will soon lose. Given today's price, I don't think the market is taking that into consideration.
A few more companies poised to pop
Our top analysts recently penned a special free report: "These Stocks Could Skyrocket After the 2012 Presidential Election." The reason I'm offering the report here is because three out of four companies identified also have PEG ratios at or below one -- just like those in this piece. To find out what those companies are, get your copy of the report today, absolutely free!
At the time thisarticle was published Fool contributorBrian Stoffelowns shares of Baidu. You can follow him on Twitter, where he goes byTMFStoffel. The Motley Fool owns shares of Portfolio Recovery Associates, SodaStream, and Baidu.Motley Fool newsletter serviceshave recommended buying shares of Baidu, Portfolio Recovery Associates, SodaStream, and Green Mountain Coffee Roasters, as well as creating a lurking gator position in Green Mountain Coffee Roasters and writing puts on Portfolio Recovery Associates. The Motley Fool has adisclosure policy. We Fools may not all hold the same opinions, but we all believe thatconsidering a diverse range of insightsmakes us better investors. Try any of our Foolish newsletter servicesfree for 30 days.
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