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speedybure (< 20)

Will The Real PEG Ratio Please Stand Up

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June 11, 2009 – Comments (2)


Something got lost in translation when investors adopted his PEG ratio. You average investor defines this ratio as the next 3-5 years growth in earninigs divided by the TTM P/E ratio.It is considered ideal if this is <1, the lower the better. It's not that I don't think this could be useful assuming you possess superior forecasting abilities, but more often than not, I see everyday investors (that which knows little to nothing regarding equity valuation) take this ratio to heart and put a incorporate this into their decision making. 

 The Real PEG ratio invented by Peter Lynch was nothing more than one of the many qualataive tests he put potential investments through. It was a requirement that the TTM P/E divided by the average growth in earninigs over the past 3-5 years be under 1.

Personally I am not to fond of either the P/E or PE/G but have created my own versions which incorporates some adjustments.

 1) Instead of P/E, I use Enterprise Value, which in my opinion is far more revealing and incorporates debt. I also go through the annual report and add off balance sheet debt (far more common than anyone thinks).

 2) Instead of using earninigs Growth, I Take EBIT growth less any one time items. This paints a clear picture of the actual growth from operations. As a non-practicing CPA, deferred taxes in any given year is more than likely. 

This was not meant to say the former ratio was wrong or faulty as finance is an art, but merely to point out to those who think that was the original formulation of the ration.  

2 Comments – Post Your Own

#1) On June 11, 2009 at 7:04 PM, JDKeene (99.26) wrote:

Thanks for the info. As a fan of Peter Lynch, I have always wondered why PEG ratio's are seldom referred to and on certain finacial websites, difficult to locate. I have also noticed, that different sources calculate PEG ratios differently. Consquently, I like you, have invented ways to calculate my own results. I prefer to use recent past quarterly results since there is no speculation involved.

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#2) On June 11, 2009 at 8:00 PM, speedybure (< 20) wrote:

JDKeene

Good Point, I have found people tend favor equities based on these like this out of laziness as opposed to doing the neccessary qualatative and quanatative analysis including reading every single foot note. 

-Cheers 

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