Source: Flickr user www.vpsi.org.
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It's a common misconception among new investors, and one that even veterans occasionally make: assuming that a stock's price is the ultimate determinant of value.
Of the more than 7,000 stocks currently listed on U.S. stock exchanges, just 428 have a share price of $100 or higher. By comparison, there are more than 900 companies to choose from with a share price of $5 or less. The perception of being able to buy more shares of a lower priced stock, as well as the idea that it'd be easier for a $5 stock to double in value than a $100 per share stock, tends to lead novice investors and short-term traders away from some very trustworthy and high growth potential triple-digit price tag stocks.
But, as noted above, this is nothing more than a misconception. Value is derived from a number of tangible and intangible factors, such as profitability, margins, and customer loyalty, and it has next to nothing to do with a company's share price.
The importance of the PEG ratio
One of my personal favorite measurements of value is the PEG ratio, or the price-earning-to-growth ratio. Rather than giving credence to where a company has been, which is what a P/E ratio does by valuing a stock based on its past profit performance, the PEG ratio takes into account both its P/E and its future growth rate. This, I believe, gives investors a much better idea of how fairly a company, regardless of share price, is valued.
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For example, a company with a P/E of 15 might appear attractive considering that the current P/E of the S&P 500 is around 20. However, if that company has a growth rate of just 3% per year, its PEG ratio will be a nightmarishly high five. For context, anything around or below one is considered a potential bargain.
On the flipside, a company with a P/E of 25 could seem pricey relative to the S&P 500. But if its growth rate is also 25%, which is not out of the question for some technology and biotechnology names, its PEG ratio of one would imply that it could still be a bargain.
Three triple-digit stocks with 40% upside (or more)
At the moment, according to Yardeni Research, as of March 23, 2015, the S&P 500 has a PEG ratio of 1.6, which historically is pretty high for the index. Over the past 20 years it's tended to average closer to 1.2 to 1.3. What this also implies is that companies trading well below a PEG ratio of 1.6 could have reasonable room to run higher.
With that in mind, let's take a quick look at three stocks whose share price is currently in triple-digit territory that I suspect could have at least 40% upside potential based solely on PEG ratio comparisons to the S&P 500 average. But as a word of caution, be aware that this is merely my opinion based on PEG ratio comparisons to the S&P 500 -- these stocks could decline in value, so you'll want to dig into each company here individually and assess whether the risks are commensurate with your own investment goals.
Apple is practically a $740 billion company, and is by far the largest company in the world. Yet it sports a PEG ratio of just 1.11, implying that it could maintain a low double-digit growth rate for the immediate future to go alongside its forward P/E of just 13.6.
Source: Flickr user Jeyullo_.
What's really amazing about Apple, and why I'd suggest it could have another 40% upside in its shares, is its ability to attract loyal customers and its seamless transition into a platform company from being just a products company.
Look around and you'll find no shortage of Apple love. From the mile-long lines at its Apple stores during product launches, to the purportedly 93% of all U.S. smartphone profits that the iPhone brought the company during the holiday quarter according to Canaccord Genuity, people can't get enough Apple. It's not surprising that Apple is often ranked at or near the top of the list in brand loyalty for a number of categories, including smartphones and tablets.
But Apple is also transforming into a next-generation platform company. It's launched a mobile payment platform known as Apple Pay, it's readying the launch of its Smartwatch which could revolutionize wearable technology, and it's even building a car. It's the epitome of cutting edge innovation, and innovation is truly everything when it comes to finding great businesses.
2. Gilead Sciences
Forget the fact that biotechnology giant Gilead Sciences shares have more than quadrupled in the past three years -- its PEG ratio implies it could still possibly double in value.
At the heart of Gilead Sciences' resounding success is its dynamic duo of drugs to treat hepatitis C: Sovaldi and Harvoni.
Source: Gilead Sciences.
Just four years ago the standard of care for HCV patients involved taking IV interferon and a ribavirin. Both of these therapies combined to cure about half of all HCV patients, but they came with nasty side effects, such as flu-like symptoms with interferon and rashes with the ribavirin. On the other hand, Sovaldi is a once-daily pill given with a ribavirin to genotype 2 & 3 HCV patients, while Harvoni is a once-daily pill for genotype 1 patients (the most common, but toughest to treat, type of HCV) that needs neither interferon nor a ribavirin. Additionally, both therapies produced cure rates in most clinical studies of 90% or higher.
Not surprisingly, Sovaldi first, then Harvoni, which was launched later, held/hold the title for the fastest growing drugs in the world. Last year both combined for $12.4 billion in product sales, yet the company only treated 140,000 HCV patients worldwide. There are more than 3 million HCV patients alone in the U.S. and 180 million worldwide, per the World Health Organization, giving the company a long tail of opportunity.
Were that not enough, investors can count on rapid growth from Gilead's four-in-one HIV/AIDS pill Stribild, as well as the ongoing development of Gilead's liver disease platform, which could include therapies to treat nonalcoholic steatohepatitis, a liver fibrosis disease affecting millions throughout the United States.
3. NXP Semiconductors
Lastly, I'd strongly urge long-term investors not to be deterred by semiconductor solutions provider NXP Semiconductors' triple-digit share price or trailing P/E of 48 and instead look at the immense potential behind the kingpin of the Internet of Things.
Source: NXP Semiconductor, Facebook.
For those unfamiliar, the Internet of Things, or IoT, simply refers to the ability of machines and appliances to connect with one another. Be it a fridge or thermostat in your household adjusting to conserve energy, or perhaps the touch or talk interface in your car, truck, or SUV, there's good chance an NXP chip could be behind it! Per research firm IDC, the IoT could be an $8.9 trillion dollar market (yes, with a "t") by 2020.
What makes NXP even more intriguing is its recent merger announcement with Freescale Semiconductor . Excluding memory developers, the merger will make it the fourth-largest semiconductor company, and the largest focused on the IoT, mobile payments via near-field communications chips, and automotive solutions. Its size will also give the company "unparalleled leverage" according to analysts at Needham & Co.
As the next generation of tech devices are brought to market I would be surprised if many didn't contain NXP-based semiconductor solutions. With a PEG ratio of just 0.8 even following its recent run higher, the implication is its shares could double just to be on par with the average PEG ratio of the S&P 500.
The article 3 Triple-Digit Stocks With Upside Potential of At Least 40% originally appeared on Fool.com.
Sean Williamshas no material interest in any companies mentioned in this article. You can follow him on CAPS under the screen nameTMFUltraLong, track every pick he makes under the screen nameTrackUltraLong, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool owns shares of, and recommends Apple, Gilead Sciences, and NXP Semiconductors. Try any of our Foolish newsletter services free for 30 days. We Fools may not all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.
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