|
The PEG ratio is a valuation metric for determining how much more should be paid (in stock price) for a company's expected future growth. It is 'generally accepted' that a (PEG = 1) is acceptable. E.g. If a company is growing at 30% a year, then it is OK to pay a P/E of 30. A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive). When the PEG is quoted it is not always clear whether the earnings used is the past year's EPS or the expected future year's EPS. It is always the expected future growth rate that is used.
Advantages Investors may prefer the PEG ratio because it explicitly puts a value on the expected growth in earnings of a company. The PEG ratio can offer a suggestion of whether a company's high PE ratio reflects an excessively high stock price, or is a reflection of promising growth prospects for the company. Disadvantages The PEG ratio is less appropriate for measuring companies without high growth. Large, well-established companies, for instance, may offer dependable dividend income, but little opportunity for growth. It does not offer much information about a company, saying nothing about the quality of the company's management. The convention that (PEG=1) is appropriate is arbitrary. Here is an example of a stock bought and held until the growth has normalized. Example Company's growth projection = 30% Number of year out you expect the growth to continue = 3 years Long term growth rate of company = 7% Current earnings of the company = $10/share SOLVE FOR YOUR OWN INVESTMENT RETURN: Stock price now so that PEG=1 ((P/10)/30=1) = $300/share Projected earnings after 3 years (PV=10,n=3,30%) = $22/share Stock price after 3 years (P/E=15=P/22) = $330/share Your personal investment return (PV=300,n=3,FV=330) = 3.2% HOLD ON! You only get a 3.2% return ??? Well... you could change the assumptions of the example. The long-term growth rate is an historical fact that is hard to argue. How about changing the number of years of growth? If you assume 5 years of growth then your personal return will be 13%. but who can really project 5 years out? Analysts can't even estimate the next year's earnings. Even more egregious is when the analysts use the forward EPS in the calculation instead of the historical. In this example, they would recommend a current price of $390. Your personal return would be a 5.4% LOSS. | ||||||||
|
| |||||||||
 |
|
| |