Stocks with a strong profit potential that, temporarily, are trading below their intrinsic value.
NEW YORK (FORTUNE) - The cornerstone of this screen is one of Peter Lynch's favorite measures, the price/earnings-to-growth, or PEG, ratio. It's calculated by dividing a company's P/E ratio by the rate at which Wall Street expects the company to boost its earnings over the next three to five years. We used it to hunt for what Lynch calls "stalwarts," blue-chip companies whose shares could gain 30% to 50% over the next couple of years if they can be purchased at the right price.
This part of the FORTUNE 40 slightly trailed the broad market last year, rising 8% on average. Our best pick was Dover (Research), an industrial conglomerate that sells everything from truck parts to printers. Its shares climbed 38% on strong sales at all its divisions. We're not recommending it again this year, however. Recent acquisitions have driven up Dover's debt level beyond our comfort zone.
With hurricane season upon us, shareholders have abandoned stocks of many property-casualty insurers. But for long-term investors, the selloff offers an attractive buying opportunity, provided they pick the right stocks. The trick is to identify those companies that have broad earnings and revenue streams, both by product and by geography, and those that are more insulated from the competitive, cyclical nature of the insurance business.
With $14 billion in sales, Chubb has carved out a number of profitable niches by insuring the precious possessions of the wealthy, from luxury automobiles to fine art. More recently Chubb (Research) has rounded out its lifestyle-related products and introduced a policy that helps customers obtain emergency medical transportation and coverage while traveling. Trading at 12 times earnings, the stock is cheap. Wall Street analysts project that earnings will grow 10% a year for the next several years.
Criteria include PEG ratios (price/earnings ratio divided by earnings growth rate) below S&P's PEG ratio of 2, long term EPS growth equal to or greater than the S&P 500's estimated 8% rate, and debt-equity below 33%. *Wall Street estimates for the next three to five years.