Move Over P/E, Make Way for the PEG

#1
It is common practice for investors to use the Price-Earnings Ratio (P/E Ratio) to determine if a company is over or undervalued. There are, however, many extreme cases of stocks trading at 50 or more times their earnings--these kinds of situations affect the ratio's accuracy for assessing a company. The companies with a high P/E ratio are typically startup companies with little or no revenues; however, a high P/E does not necessarily mean the stock isn't a good buy for the long term.

Let's take a closer look at what the P/E ratio tells us:

P/E Ratio = Market Value per Share /Earnings per Share (EPS)

There are two primary components here, the market value (price) of the stock and the earnings of the company.

Earnings are very important to consider. After all, earnings represent profits, for what every business strives. Earnings are calculated by taking the hard figures into account: revenue, cost of goods sold (COGS), salaries, rent, etc. These are all important to the livelihood of a company. If the company isn't using its resources effectively it will not have positive earnings, and problems will eventually arise.

Besides earnings, there are other factors that affect the value of a stock. For example:

Brand - The name of a product or company has value. Certain brand names are worth billions.

Human Capital - Now more than ever, a company's employees and their expertise are thought to add value to the company. It's about time!

Expectations - The stock market is forward looking. You buy a stock because of high expectations for strong profits, not because of past achievements.

Barriers To Entry - For a company to be successful in the long run, it must have strategies to keep competitors from entering the industry. Coca-Cola, for example, has built a very extensive distribution channel--anybody can make pop, but getting that product to the market like Coke does, is very costly.

All these factors will affect a company's growth rate. The P/E ratio does not reflect any of these, and only looks at the past.

The relationship between the price/earnings ratio and earnings growth tells a much more complete story than the P/E on its own. This is called the PEG Ratio and is formulated as:

PEG Ratio = PE Ratio/Annual EPS Growth*

* The number used for annual growth rate can vary. It can be forward (predicted growth) or trailing, and either a 1 to 5 year time span.

Looking at the value of PEG of companies is just like looking at the P/E ratio: a lower PEG means that the stock is more undervalued.

Investors are getting more savvy. Many have abandoned the P/E ratio, not because it is worthless, but because they desire more information about a stock's potential.

The P/E doesn't tell us everything we need to know. Using the P/E along with current growth rates produces the more informative PEG ratio, a great indicator of a stock's potential value.
 

Einstein

Well-Known Member
#2
P/E Ratio = Physciology Ratio, It does not tell anything but what market think of a company. if market think company is good, PE will be higher means higher PE. If market(peoples/investors) think its bad company (they will sell, hence lower market cap). hence lower P/E.

PEG ratio = speculation ratio EPG growth is completely speculation, no one have every predicted the exact EPS of a company ever, not even company's management can do that.
 
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Einstein

Well-Known Member
#4
I never said im depending on PE to tell if market is overvalued or undervalued, this is what generally what price to equity ration means...

will check it on some companies with trailing eps's growth rate.. But again, how will you calculate eps ttm growth rate?? average of last 4 quarters??

add:- tried it on some companies, and its again useless in cyclical industries, high dividend growing and stable companies and most of the sectors where earnings fluctuate like reality sector.

It does not tells if company is undervalued or not, but tell whether the company's growth rate(ttm) is line with the market value of the company or not. lower number (less then 0.50) means NOT, higher 1.5+ means NOT again.
 
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#5
Why are you depending on the market to tell if a company is good or bad?



Its not a speculation ratio if you are using trailing growth rate.
I have never heard anyone using trailing growth rate, it is always expected or estimated. Now you could have forward and trailing PEG but I have rarely heard someone using these terms to define PEG ratio.
 

aryan.

Active Member
#6
I have never heard anyone using trailing growth rate
Its not useful for trading short term but if you are a serious long term investor you need to know the historical growth rate of the company first.

The estimate which most people come up is not accurate most of the times which is why you look at the trailing rate to see how it has performed historically.

add:- tried it on some companies
Can you tell which companies did you try?
 

Mr.G

Well-Known Member
#8
P/E is idiots play! It is volatile! Listen to einstein. Dont use P/E it is used just to make predictions by people who don't know nothing about fundamental analysis and brand themselves analysts.

or PEG matter of fact.
 
#9
P/E is idiots play! It is volatile! Listen to einstein. Dont use P/E it is used just to make predictions by people who don't know nothing about fundamental analysis and brand themselves analysts.

or PEG matter of fact.
I would be very cautious with the words you use especially when you are a professional money manager, this is my guess. It is an important measure and you cant ignore it. It is also an important screen.

In the past this is how people have differentiated between growth and value play.

Ben Graham used it, Warren Buffet uses it, Peter Lynch has written about it and if you have knowledge about industry then Fama and French have also used it and published paper about their three factor model.

David Einhorn, Karl Icahn and many more people use it. It is an important metric to compare stocks in the same industry.

All these details for you just to prove a point that be cautious(and humble) when and what you write.
 

Mr.G

Well-Known Member
#10
I am all but humble, and sometimes I do spit out words before thinking. I have experimented a large amount with earnings. I have found out that earnings are so volatile from a valuation perspective. More than that, lets assume the earnings are stable. If anyone has picked up security analysis (80% never do that) then you will find there are a number of way the company can screw over the earnings.

And anything that involves predicting the future market movement is not valuation. PEG.

Valuating a stock and predicting a stock are two different things. - Warren Buffet

I am sorry but there are more accurate and more stable ways to calculate value, I rather wish my investing friends wont fall in the P/E trap anymore.
 

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