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What in the world
is a PEG?
By Ken
Kurson • Bankrate.com
Most investors have heard about P/E
(Price/Earnings) ratio and know how useful it can be. That's
why they print it in the newspaper and on stock quotes you get online.
But a company's p/e ratio only looks backward since it compares
a company's CURRENT price to its PAST earnings. Investors are more
interested in what a stock will do than what it has done.
One tool, abbreviated like a lot of Margarets simply
as PEG, looks forward and has proven quite useful. PEG is the ratio
of a stock's p/e value to its expected earnings growth rate. If
a company's stock is trading at 20 times its last year's earnings,
it has a p/e of 20. If the earnings of that company are predicted
by the analysts who follow it to grow 20 percent a year for the
next several years (or however long the analysts have projected
its earnings), then its PEG is 1, since 20/20 is 1.
The PEG was pioneered by the Motley Fools, and it's
really clear: a stock with a PEG of 1 is thought to be cheaper than
a stock PEGged at 2 but more expensive than a stock with a PEG of
.5. Remember, what stock investors hope to buy is a company that's
growing its profits faster than other companies of similar risk.
Paying $10 for a dollar of earnings expected to grow 10 percent
a year is a better deal than paying $20 for that same dollar of
earnings at the same expected growth rate. And a stock that's selling
a dollar's worth of earnings with an expected growth rate of 10
percent a year for only $5 is, comparatively, a real bargain.
Because it relies on correct growth projections, PEG
is better suited to valuing stocks that are growing quickly, like
many Internet companies. Large, stable companies don't typically
enjoy big spurts in earnings growth, so the difference between one
conglomerate's PEG and another isn't so meaningful. While PEG is
best for small and quickly growing companies, it can only be used
for those with enough earnings to have a P/E and enough analyst
coverage to have meaningful estimates.
There's a trick here, too. When dividing by the expected
growth rates, you have to be certain to use ANNUALIZED growth rates.
If you're using a one-year estimate, that's no problem -- it's already
annualized. But you get more accurate results with longer-term estimates
-- say 2-3 years -- and annualized numbers aren't so easy to find.
Keep in mind, of course, that when you're dealing
with expectations, there's an inherent margin for error -- earnings
forecasts are only slightly more reliable than weather forecasts.
And also remember that there is no "magic indicator" -- lots of
other investors have access to the same information as you and if
they're not pouncing on that .5 PEG stock there might be a good
reason you shouldn't either.
Nevertheless, PEG remains an excellent tool for comparing
the value of one stock to another. Despite its growing popularity
as a valuation tool, a stock's PEG is hard to come by -- it's not
printed in the newspaper, nor does it show up when an investor calls
up a quote on the Net. But its components are easily learned --
the p/e ratio is everywhere, and the expected earnings are available
from First Call, Zack's and elsewhere. Even a die-hard math hater
can divide one number into another -- for a stock you're hoping
to stick with for a while, it's worth the effort.
-- Posted: June 28, 2000 |
