The other day I read an excellent article on Seeking Alpha by another author about a new valuation metric, the GAPE ratio. So I thought I would try to create my own valuation ratio, rather than focusing just on using fundamental inputs like the ones that go into traditional ratios like the PE Ratio, PEG rates, Price/Sales, etc, I also wanted to include something with technical analysis.
Overall, I wanted the formula to be fairly simple and easy to calculate. Below I will show the steps that I used to construct my formula.
First, I picked a base formula that I could expand on, and I decided to start with a modified PEG ratio. For my version of the PEG ratio, instead of using the trailing PE ratio like the PEG ratio does, I decided to use the forward PE ratio. Therefore, "FPE" will represent this in my equation.
Reason for Choosing Forward PE:
The reason I chose to include the forward PE instead of a trailing PE, is because I believe that stocks trade on what they are expected to earn, rather than what they have earned in the past.
For the growth section, I kept the same source of growth, which is the long-term [next 5 years] expected growth rate. Therefore, "G" will represent this in my equation.
Reason for Choosing Long-Term Growth:
The reason I chose to include a long-term growth estimate is because in a traditional PEG ratio, I like being able factor in growth to the equation. I like that because for example there could be two companies could be trading at close to the same PE ratio but have different long-term growth estimates, and by including growth it can help identify the true undervalued stock.
My second step was to add a technical metric onto the fundamental metric I created in step 1. I decided to use the percentage that a stock was above or below its 50-day moving average. Therefore, "A" will represent this in my equation.
Reason for Choosing a 50-Day Moving Average:
The reason I chose the 50-day moving average was because it is a good short-medium term indicator of a stocks trend. For example, two stocks could have the same, or close to the same PEG ratio, and say stock "A" is trading 5% below its 50 day moving average, and stock "B" is trading 5% above its 50 day moving average, therefore using the FPEGA ratio, stock "A" would be undervalued as compared to stock "B".
So combining each of the parts of my three steps my final formula for what I am calling the FPEGA ratio is:
Sample calculation of my formula comparing two like companies
The two companies I will use for my calculation are Visa (V) and MasterCard (MA), I chose these companies because they are as close to the same company as any pair I can think of. The data I am using for each company is from Finviz.com.
Forward PE: 19.13
Long term-Growth: +18.73
Percentage Above/Below 50 day Moving Average: +8.81%
FPEGA Ratio: (19.13/18.73) =1.02*(1+8.81%) = FPEGA ratio of 1.11
Forward PE: 20.60
Long term-Growth: +18.18
Percentage Above/Below 50 day Moving Average: +9.47%
FPEGA Ratio: (20.60/18.18) =1.13*(1+9.47%) = FPEGA ratio of 1.24
S&P 500 FPEGA Test
The final item I wanted to include was a calculation of the FPEGA ratio for all stocks in the S&P 500. Then I will track the stocks with the lowest FPEGA ratios and see how they perform over time. For my data collection, I used the Finviz.Com Screener and used the following screen criteria:
Index: S&P 500
Forward P/E: Profitable
After entering those criteria, I clicked on the "Custom" tab and selected the boxes that said Forward PE, EPS Growth Next 5 years, and 50-day simple moving average. I then exported those results to a spreadsheet, then entered my formula and calculated the FPEGA ratio for each stock. In the table below is a list of the top five stocks that had the lowest FPEGA ratio.
5 Lowest FPEGA ratio Stocks
Goodyear Tire & Rubber Ord Shs
Goldman Sachs Group Inc
5 Lowest Traditional PEG ratio Stocks
Traditional PEG Ratio
American International Group Inc
Seagate Technology PLC
MetroPCS Communications Inc
Harman International Industries Inc
I am very interested to see how my FPEGA ratio will perform in the coming months and year. In addition, it will be interesting to see how adding a technical analysis aspect will affect the results. In the future, I will see how the average returns of the above five FPEGA stocks compares to the S&P 500 as a whole, as well as comparing them to the five stocks with the lowest traditional PEG ratio in the S&P 500.
Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.