The Price Earnings
Ratio - PE
The P-E/growth
connection - Information on the price-earnings ratio
(P-E) to help you buy the right stock.
The price-earnings (P-E) ratio
can help gauge the 'value' of a stock. P-E tells us
at how many times a company's earnings per share (profits)
its stock is trading. But what that measure does not
tell us is how a share can have a high P-E and still
be an attractive buy. That's where PEG is of help.
PEG is the ratio of a company's P-E to its earnings
growth rate. A company with a high P-E can be an attractive
buy if its growth rate is also higher than that of
a comparable company with a lower P-E and slower growth
The lower the PEG, the better the share price. A
PEG ratio below 1 means that the share is attractively
priced and a PEG above 1 means indicates that it's
expensive. Let's have the final word from Peter Lynch,
as quoted in one up on Wall Street. "The P-E
ratio of any company that is fairly priced will equal
its growth rate. In general, a P-E ratio that is half
the growth rate is very positive. A P-E ratio that
is twice the growth rate is generally very negative."
While weighing whether a stock is attractively priced
or not, one could do with an idea of how the share
will be valued in a year or so. So a PEG based on
expected earnings growth is qualitatively better than
one based on current earnings.
Earnings estimate can be had from reputed research
firms or can be taken as the average at which earnings
have grown in the last 3-5 years. Stock Analysts often
provide growth projections. But you will realize that
reliable projections are not that easily available.
That's one of the reasons why different people perceive
the same share differently.
If good estimate are not available, a PEG based on
the current P-E is the next best thing. You don't
have to calculate the P-E; all financial newspapers
carry it.
A comparison of only the P-Es would ignore the rate
of growth in earnings. After all, the company with
a higher growth rate would recover your investments
faster. This is where PEG comes in.
Based on next year growth rates, the valuation gap
between the banks would reduce if they stay at the
price indicate in the table. But the aim is also to
project what the future price could be, instead of
assuming one.
PEG sets the pitch for rational economic evaluation
- something that may not always be reflected in market
sentiments. But one should heed a dictum of investor
extraordinaire Warren Buffet's mentor, Ben Graham:
"The stock market is a voting machine in the
long term."
One caveat: PEG analysis
by itself is not comprehensive enough, as it does
not consider factors like management skills and overall
asset quality. As ever, one is advised to supplement
technical analysis with qualitative ones.
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