Thursday, August 18, 2011 7:27:23 PM
just calculating the p to e is nothing, you want to verfy that it is worth that and will continue that p to e number.
so without peg orypeg, your company wont be allowed to keep its current p to e of 10, you have to have the growth in the future to back up your current valuation
The PEG and YPEG
Two commonly used applications of the P/E ratio are the P/E and growth ratio (PEG) and the year-ahead P/E and growth ratio (YPEG).
The PEG simply takes the annualized rate of growth out to its furthest estimate, then compares this with the trailing P/E ratio. Since future growth makes a company more valuable, it makes sense that higher growth rates should increase a company's valuation. Relying solely on a trailing P/E in this regard would be like trying to drive with your eyes fixed on the rearview mirror.
For instance, if a company is expected to grow at 10% a year over the next two years, and it has a P/E of 10, it will have a PEG of 1.
10 trailing P/E / 10% projected EPS growth rate = 1.0 PEG
The lower the PEG ratio, the more cheaply a company is valued. If the company in the above example only had a P/E of 5, but was expected to grow at 10% a year, it would have a PEG of 0.5. If the company had a P/E of 20 and expected growth of 10% a year, it would have a PEG of 2.
While the PEG is most often used for growth companies, the YPEG is best suited for valuing larger, more-established ones. The YPEG uses the same assumptions as the PEG, but it looks at different numbers. Rather than basing the P/E ratio on trailing earnings, it compares the stock price to earnings estimates for the year ahead. It then uses estimated five-year growth rates, which are readily available from several quote sources. Thus, if the forward P/E is 10, and analysts expect the company to grow at 20% over the next five years, the YPEG is equal to 0.5.
Fools should view the PEG and YPEG in the context of other measures of value, rather than considering them magic money machines.
Multiples
Rather than trying to look at growth rates, many investors simply look at estimated forward earnings, then guess what fair multiple someone might pay for the stock. For example, suppose XYZ Corp. has historically traded at about 10 times earnings, and it's currently down to 7 times earnings because it missed estimates one quarter. If the missed quarter was just a short-term anomaly, it would be reasonable to expect that the stock will return to its historic 10 times multiple.
When you project fair multiples for a company based on forward earnings estimates, you start to make a heck of a lot of assumptions about what that company will do in the future. With enough research, you can reduce the risk of being wrong, but it will always still exist. Should one of your assumptions prove incorrect, the stock probably won't go where you'd expect it to. That said, most of the other investors and companies out there are using this same approach, making their own assumptions as well. In such a worst-case scenario, at least you won't be alone.
In a modification to the multiple approach, you can also determine the relationship between the company's P/E and the average P/E of the S&P 500. If XYZ Corp. has historically traded at 150% of the S&P 500, and the S&P is currently at 10, many investors believe that XYZ Corp. should eventually hit a fair P/E of 15, assuming that nothing changes. This historical relationship requires some sophisticated databases and spreadsheets to figure out, and it's more often used by professional money managers than individual investors.
my head hurts really really hurts
the dr
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