Real Estate

Understand the PEG ratio of a stock

A PEG ratio cannot be used alone, but it is a very powerful tool when integrated with the basics (price, volume, and chart reading). You should enjoy doing numbers and have a calculator handy to estimate your own PEG ratio. Access to quality statistical information from the web, such as past earnings and future earnings estimates, is essential to calculate this critical metric. A variety of websites produce a PEG ratio, but I have not found a site that has a reliable PEG ratio that I can use for my own research, so I calculate it myself, ensuring accuracy with the final number.

I’m going to use the definition from investopedia.com as it makes a lot of sense and doesn’t get too confusing (below the definition is a more detailed explanation and current example in real time, using Apple Computer):

The PEG ratio:

“The PEG ratio compares the price / earnings ratio (” P / E “) of a stock to its expected EPS growth rate. If the PEG ratio is equal to one, it means that the market is pricing the stock to fully reflect the stock’s EPS growth.This is “normal” in theory because, in a rational and efficient market, the P / E is supposed to reflect the future growth of a stock’s earnings.

If the PEG index is greater than one, it indicates that the stock is possibly overvalued or that the market expects future EPS growth to be greater than the current Street consensus number. Growth stocks typically have a PEG greater than one because investors are willing to pay more for a stock that is expected to grow rapidly (also known as “growth at any price”). It could also be that earnings forecasts have been lowered while the share price is relatively stable for other reasons.

If the PEG index is less than one, it is a sign of a potentially undervalued stock or that the market does not expect the company to achieve the earnings growth reflected in Street’s estimates. Value stocks generally have a PEG rating less than one because earnings expectations for stocks have risen and the market has yet to recognize growth potential. On the other hand, it could also indicate that earnings expectations have fallen faster than the street could issue new forecasts. ”

– provided by www.Investopedia.com

PEG relationship example:

Using Apple Computer Inc., I will demonstrate how to calculate the PEG ratio without relying on other websites.

First, you will need to collect the previous win numbers; going back at least 2 years and moving forward two years. (All data are from Thursday, June 23, 2005)

AAPL:

2003: 0.09

2004: 0.36

2005: 1.31 (Mi)

2006: 1.52 (E)

Now we need to calculate the growth from one year to the next.

Subtract the 2004 earnings by 2003 and then divide by 2003.

Repeat the process to determine the growth rate for the following years:

2004: (0.36-0.09) /0.09 x 100 = 300% growth rate

2005: (1.31-0.36) / 0.36 x 100 = growth rate of 264%

2006: (1.52-1.31) / 1.31 x 100 = growth rate of 16%

Now, take the current price (we’ll use Thursday June 23, 2005’s close: $ 38.89) and divide it by the 2004 earnings and then by the 2004 growth rate:

2004: 38.89 / 0.36 / 300 = .36 PEG ratio

2005: 38.89 / 1.31 / 264 = .11 PEG ratio

2006: 38.89 / 1.52 / 16 = 1.59 PEG ratio

Using the definition above, Investopedia states that a stock is valued uniformly at a PEG ratio of 1 in a rational and efficient market. Please note that the stock market is not very rational or efficient, so we only use this number as a secondary indicator and tool, once our fundamental and technical analysis is complete. Apple’s PEG ratio of 0.11 for 2005 was discounted in the price when these estimates were first released, giving us a big increase late last year. Looking ahead, the earnings potential of the stock appears to decline considerably and the PEG ratio clearly shows us the tremendous jump in numbers from 2005 to 2006. A PEG ratio of 1.59 for 2006 is not the best rating going forward, but it is still below the red flag ratio of 2.00.

Finally, once you determine the PEG ratio of the stocks you want to buy, take the time to calculate the PEG ratio for the “sister stocks” in the industry group to see if they have higher or lower PEG ratios. . Note that PEG ratios do not work for companies with negative or non-existent earnings figures.

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