**Peter Lynch's PEGY Ratio**

In Chapter 13 (Some Famous Numbers) of his book "One Up On Wall Street," Peter Lynch introduced an improvised version of the classic P/E ratio, which is now more widely referred to as the PEGY ratio. The PEGY ratio is calculated by dividing the P/E ratio by the sum of the long-term earnings growth rate and the dividend yield. Peter Lynch highlighted that a stock trading at below 0.5 times PEGY will be very attractive e.g. a company boasting a dividend yield of 5% and an earnings growth rate of 15%, while valued by the market at 10 times P/E [PEGY = 10 / (5+15).]

Peter Lynch understood the limitations of the P/E ratio as a stand-alone valuation metric very well. In "One Up On Wall Street," he explained why different stocks trade at varying P/Es and the real bargain is a stock valued at a low P/E relative to its growth prospects:

An average p/e for a utility (7 to 9 these days) will be lower than the average p/e for a stalwart (10 to 14 these days), and that in turn will be lower than the average p/e of a fast grower (14-20). Some bargain hunters believe in buying any and all stocks with low p/e's, but that strategy makes no sense to me. We shouldn't compare apples to oranges. What's a bargain p/e for a Dow Chemical (NYSE:DOW) isn't necessarily the same as a bargain p/e for a Wal-Mart (NYSE:WMT).

If the p/e of Coca-Cola (NYSE:KO) is 15, you'd expect the company to be growing at about 15 percent a year, etc. But if the p/e ratio is less than the growth rate, you may have found yourself a bargain. A company, say, with a growth rate of 12 percent a year (also known as a "12-percent grower") and a p/e ratio of 6 is a very attractive prospect. On the other hand, a company with a growth rate of 6 percent a year and a p/e ratio of 12 is an unattractive prospect and headed for a comedown.

Peter Lynch also appreciated the value of dividends in the investment equation by including the dividend yield in the computation of the PEGY ratio. He also wrote in the book that "regular checks in the mail gave investors an income stream and also a reason to hold on to stocks during periods when stock prices failed to reward." In my opinion, this also makes the PEGY ratio more "balanced" than the PEG ratio (merely dividing the P/E ratio by the earnings growth rate), since one should not unfairly penalize a mature company for its modest growth prospects if it is returning excess capital to shareholders.

**The PBGY Ratio For Deep Value Investors**

I focus on balance sheet bargains, or in other words buying assets at a discount, for my deep value investment strategy. Potential investment candidates in the deep value category include negative enterprise value stocks, net-nets, sum-of-the-parts discounts and also low P/B stocks.

Like any other valuation ratio, the P/B ratio has its flaws and I was inspired by Peter Lynch's PEGY ratio to come up with the PBGY ratio (my own terminology). The PBGY ratio is derived by dividing the P/B ratio by the sum of the long-term book value per share growth rate and the dividend yield.

I have already elaborated on the merits of a low P/B ratio and the presence of dividends in my articles "Seeking U.S. And Hong Kong Low P/B Stocks With Recent Insider Buying" and "Seeking Asian Dividend Challengers As Deep Value And Wide Moat Investment Candidates" published here and here respectively.

Here, I will highlight why book value growth is a critical factor to consider for deep value investors. Unlike wide moat stocks where investors earn their returns from the "internal compounding" of intrinsic value, deep value stocks typically reward their shareholders through mean reversion or the positive re-rating of their P/B multiples. If the deep value stock is delivering decent book value per share growth, it implies the stock's discount to net asset value will widen if the share price remains stagnant (since the denominator of the P/B ratio, book value is growing). The investment thesis here is that the market cannot afford to ignore a stock whose P/B ratio keeps on going lower, while it is profitable and compounding book value over time.

The "theory" above is validated by a July 2014 study by Third Avenue investment analysts. The analysts ran a global stocks screen for the following criteria:

- Ten year book value per share increased by at least 10% per annum;
- The common stock was selling at 1 times tangible book value, or less; and
- Market cap greater than $1 billion.

The results of the Third Avenue study for the top 100 most well capitalized companies (with total debt to capitalization ranging from 0% to 30%) for a 10-year period were as follows:

- The largest annualized loss was only 6.7% for the 10 stocks without positive price appreciation;
- 55% of the companies achieved annualized returns above 10% at the minimum; and
- 13 of the stocks delivered 10-year annualized returns in excess of 20%.

**List Of U.S. And Asian Low PBGY Stocks**

The PEGY ratio works on the premise that it is fair that an average stock returning 10% (either through dividend yield or earnings growth) is fairly valued at 10 times P/E, so a PEGY ratio of 0.5 is attractive e.g. a stock yielding 20% trading at 10 times P/E, or a stock boasting a P/E ratio of 5 delivering earning growth in excess of 10% etc. Extending the reasoning behind the PEGY ratio to the PBGY ratio, a stock trading at book value should yield 10% at the minimum (a mix book value growth and dividends). This implies a PBGY ratio of 0.05 will be compelling to investors e.g. a deep value investment candidate valued by the market at 0.5 times book with a book value per share growth of 5% and a dividend yield of 5%.

I screened for U.S. and Asian low PBGY stocks fulfilling the following criteria (Note that I used historical five-year book value per share CAGR as a proxy for long-term book value growth):

- PBGY ratio less than 0.03 (I used 0.03 instead of 0.05 to further narrow the investable universe)
- Debt-to-equity ratio under 1
- P/B ratio below 1
- Dividend paying
- Market capitalization over US$200 million

The top 20 most attractive deep value investment candidates starting with the ones having the lowest PBGY ratios are as follows:

- Lai Sun Garment (OTC:LSIHF) (191 HK)
- Atwood Oceanics (NYSE:ATW)
- Asia Standard International Group (OTC:ASASF) (129 HK)
- Tidewater Inc. (NYSE:TDW)
- Lai Sun Development Company (OTCPK:LVSDF) (488 HK)
- Trigiant Group (OTC:TIGGF) (1300 HK)
- Powerlong Real Estate Holdings (1238 HK)
- Emperor International Holdings (OTC:EPRRY) (163 HK)
- J Trust Co Ltd (8508 JP)
- Tsukuba Bank (8338 JP)
- Subsea 7 SA ADR (OTCPK:SUBCY)
- Wing Tai Properties (369 HK)
- Regal Hotels International (OTC:REGHF) (78 HK)
- Hsin Chong Construction Group (404 HK)
- Playmates Holdings (OTCPK:PYHOF) (635 HK)
- K Wah International Holdings (173 HK)
- Great Eagle Holdings Limited (OTCPK:GEAHF) (41 HK)
- Springland International (OTCPK:SPRHY) (1700 HK)
- Wheelock and Company Limited (OTCPK:WHLKY) (20 HK)
- DRB-Hicom Berhad (DRB MK)

The full list of 124 stocks passing the PBGY ratio screen are available to my subscribers in a separate bonus watchlist article.

*Note: Subscribers to my Asia/U.S. Deep-Value Wide-Moat Stocks get full access to the watchlists, profiles and idea write-ups of deep-value investment candidates and value traps, which include net-nets, net cash stocks, low P/B stocks and sum-of-the-parts discounts.*

**Disclosure:** I/we have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours.

I wrote this article myself, and it expresses my own opinions. I am not receiving compensation for it. I have no business relationship with any company whose stock is mentioned in this article.