The Dow's 3 Cheapest Stocks Based on the PEG Ratio

By Markets Fool.com


Image source: Getty Images.

Continue Reading Below

Although it's been a volatile year for stocks in general, the Dow Jones Industrial Average , arguably the most iconic index followed by investors worldwide, is within striking distance of an all-time high. Rising stock prices can swell portfolios and make for happy investors, but they can also make Wall Street worry about the rally's longevity.

The cheapest Dow stocks based on PEG

The price/earnings-to-growth, orPEG, ratio is a value measure that not only factors in where a company is currently trading relative to its profits, but also where it's valued relative to its future growth potential. Companies with a PEG ratio around or below one are often considered to be priced attractively relative to their future growth prospects, while a PEG north of two often brings out the overvaluation skeptics.Within the Dow, there are more than a handful of companies trading at a PEG ratio north of three.

As long-term buy-and-hold investors, we strive to find attractive companies with solid business models that are trading at relative discounts to their peers and the market in general. After running a quick screen of all 30 Dow components using data from Thomson Reuters, the following Dow stocks stood out as its cheapest based on their PEG ratios. Data is through market close on June 20, 2016.


Image source: Getty Images.

Continue Reading Below

Goldman Sachs: PEG ratio of 0.58

Investment bank Goldman Sachs is the only Dow component with a PEG below one, and is hands down the cheapest Dow stock by a mile. Unfortunately, cheapness doesn't necessarily correlate to "screaming buy" in Goldman's case.

A number of factors have been working against Goldman Sachs in recent years, including a protracted decline in bond trading and a continuation of stock market volatility, which has made it difficult for Goldman to make a market in fixed-income securities. More recently, market uncertainty has slowed merger and acquisition activity from a record level in 2015, sending revenue in this segment lower. During the first quarter, Goldman Sachs' investing banking revenue slipped 23%, while institutional client service revenue plunged 37%.

The hope, though, is that the Federal Reserve will be able to curb stock market volatility and return interest rates to normal levels, potentially bolstering activity in the bond market and allowing Goldman to ease off of its cost-cutting efforts to drive profits. While this seems like a reasonable expectation over the intermediate-term, investors should understand that Goldman Sachs' top- and bottom-line could be quite volatile in the coming quarters.

Goldman's management team has made it quite clear that it plans to stay the course with fixed-income securities; so until we see a rebound here, Goldman's upside could be limited.


Image source: Getty Images.

UnitedHealth Group: PEG ratio of 1.18

Another inexpensive Dow stock based on PEG is the nation's largest health insurance provider,UnitedHealth Group .

On the one hand, UnitedHealth Group has struggled mightily on Obamacare's marketplace exchanges. After losing more than $400 million in 2015, UnitedHealth warned of another $500 million in losses in 2016. Moving forward, UnitedHealth is bowing out of most of the 34 states it's operating in this year by 2017 in order to reduce what it views as unsustainable losses.

However, Obamacare aside, UnitedHealth's core business is rocking. UnitedHealth's Optum segment witnessed its revenue climb 54% year-over-year to $19.7 billion in Q1, driven primarily by 72% growth in OptumRx, which fulfilled a whopping 252 million scripts. The company's Medicare and Retirement segment also grew by 10%, with revenue jumping to $14.1 billion. Medicare Advantage continues to be a steadily growing segment for UnitedHealth.

The long-term outlook for UnitedHealth is also bright. The latest U.S. Census data shows that between 2012 and 2050 the elderly population is expected to nearly double to 83.7 million. Compound this expectation with increasing life expectancies and we have a growing justification to be bullish on UnitedHealth and the healthcare sector as a whole. Older Americans require more medical care, which gives UnitedHealth an ample amount of pricing power on its health plans and through its Optum segment.


Image source: Cisco Systems.

Cisco Systems: PEG ratio of 1.18

Last but not least, networking equipment giant Cisco Systems comes in with a PEG that's also below 1.2, potentially implying that it could be cheap relative to the overall market and its peers.

The biggest issue for a company like Cisco Systems is that it requires steady investments from enterprise customers in order to grow its top- and bottom-lines. The U.S. economy is naturally cyclical, meaning from time to time Cisco's core business is going to struggle to grow.

However, like UnitedHealth, there are plenty of reasons to be bullish about the company's future. For example, Cisco is a key player in the cloud and enterprise data centers. Demand for networking and storage is only expected to increase as businesses move into the cloud, and Cisco maintains a large chunk of market share in both legacy networking and next-generation cloud networks. According to Market Research Media, the global cloud-computing market is expected to grow by 30% on a compound annual basis between 2015 and 2020, which bodes well for Cisco.

Cisco can also use its enormous operating cash flow, which totaled $13.9 billion over the past 12 months, to reward its shareholders and/or make acquisitions. Cisco is currently paying out a hefty 3.5% dividend yield, and it's possible its payout could increase further with a payout ratio of just 44%. It also recently used its more than $62 billion in cash on hand to purchase Jasper Technologies for $1.4 billion to further get its foot in the door in the Internet of Things cloud platform.

With a forward P/E of less than 12 and a growing demand for data, Cisco looks like a smart long-term play.

The article The Dow's 3 Cheapest Stocks Based on the PEG Ratio 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, and check him out on Twitter, where he goes by the handle@TMFUltraLong.The Motley Fool recommends Cisco Systems and UnitedHealth Group. 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.