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How Can the PEG Ratio Be Used to Value Stocks?
The exponents are easier to read in the original article at lloydsinvestment.blogs...
I agree that PEG is a quirky measure. The purpose of the article is to explore the ratio and show how one might attempt to put it to use, despite its shortcomings. As indicated in the article, the factor of 100 enters the definition of PEG only to convert from a percentage growth rate to a percentage point growth number, which you'll see is necessary to get the arithmetic right. Equating the terminal PE ratio with 100G is merely a broadbrushed way (motivated by PEG=1 thinking) of arriving at a "benchmark" set of terminal prices for calculating and comparing pro forma returns, without claiming to be "predictive" in any sense of the term.
Not to play devil's advocate, but isn't it a little contradictory to call DCF "correct" if, as you point out, "it doesn't really matter" because it relies on growth and discount rates that themselves are only guesses? I have yet to come across a universally useful, reliable, non-controversial technique for judging the value of stocks and companies.
I find that ratio analysis is a good way to screen for outliers that may in turn be analyzed in further depth by reading a company's 10Q and 10K reports and other SEC filings, industry reports, news, financials of competitors, etc. You are right in recommending that investors do their own analysis, yet one also wonders why Wall Street analysts, who build their careers on doing precisely that, do not appear to have an edge over others when it comes to stockpicking.
Oct 23, 2007. 07:33 PM
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