Saturday, June 14, 2008

Using The PEG Ratio To Find Value

The PEG Ratio is often referred to as the P/E to Growth Rate measure. P/E is a company's price per share divided by earnings per share. The growth rate can by a company's 1 or 3 year compound annual earnings per share growth rate. The lower a company's PEG ratio the cheaper the stock relative to the company's earnings growth.
  • P/E = Price Per Share/Earnings Per Share
  • PEG Ratio = (P/E)/Earnings Per Share Growth Rate
The importance of comparing PEGs across different stocks is the PEG enables an investor to uncover stocks that may trade at relatively high P/Es because the company's earnings are expected to grow at a faster rate than maybe a lower P/E stock. An example in the below spreadsheet is CSX Corp. (CSX) that trades at a P/E of 21.3 with an earnings growth rate of 24% (PEG = .87) versus Entergy (ETR) that trades at a P/E of 19.8 with an earnings growth rate of 14% (PEG = 1.45).

One must evaluate a company's PEG relative to the company's historical PEG ranges as well as evaluate the PEGs across industries. Some stocks may generally trade at higher P/Es relative to their growth rate due to the long term stability of that company's earnings. Also, a company may trade at a lower PEG due to the market anticipating negative earnings news from the company. A good example of this is Textron (TXT). Textron trades at a 1.2 PEG; however, after the close Friday, Textron announced in an SEC filing that top end earnings would be lower due to issues at the company's finance unit. The stock traded down 5% in Friday's after hours session.

As noted in my earlier post on using Enterprise Value As A Starting Point For Finding Bargain Stocks, no one single metric should be used when determining the appropriateness of a specific investment. Nonetheless, the PEG ratio is another variable an investor can use when screen ing for stocks.

In conclusion, it is useful to use several variables in one's stock screening exercise. I have found Microsoft's (MSFT) Money site contains a fairly advanced stock screen tool. The screening tool works best in Internet Explorer.

No comments :