Use the PEG ratio for a fuller picture of a stock’s price | Retire on Track
On Oct. 13 I read commentary from various market analysts saying that we’ve reached a bottom. The day had started off with further selling, only to see the S&P 500 end the day up 2.6%, a wild swing of 5% for the day. Some of the recovery was undoubtedly from programmed trading, and the day’s economic news wasn’t great, but it’s also possible that investors were also encouraged by good earnings news from Walgreen’s, Delta, and others.
So for an individual investor who has watched stocks drop about 25%, you’re probably asking yourself whether stocks are cheap. One of the quickest first steps to determining that is to know a stock in question’s PEG ratio.
The PEG ratio is the relationship between a stock’s price-earnings ratio (the most common way to value a stock’s cost) with the company’s growth in earnings per share. Legendary mutual fund manager Peter Lynch popularized the ratio in his books, and though there are skeptics, many analysts and portfolio managers use PEG as one of their valuation points.
It’s a simple enough calculation. Just take the stock’s P/E and divide it by the expected growth rate. You can find analysts’ consensus annual earnings growth estimates at Yahoo Finance and other financial news sites. Note that you’ll get different numbers depending on which earnings growth estimate you use. Estimates might look out over one year, three years or five years. I prefer a three- or five-year outlook for PEG ratios.
Using Home Depot as an example, the current P/E is 17.4. Analysts are expecting five-year annual earnings growth of 15.7%. So in this case, the PEG is 1.1.
Does a PEG of 1.1 indicate Home Depot is reasonably priced? It depends on the analyst. Peter Lynch looked for a ratio of 1.0 or less, while other experts are OK with a PEG of 1.2, 1.5 or even higher. I don’t have rules that are carved in stone when I look at PEG because it’s just one of several measures I consider. A PEG of 1.1 seems pretty reasonable to me, though.
Another reason I don’t have set standards for the PEG is that some stocks historically have had high P/Es relative to their expected growth rate. Their high P/Es might be because they enjoy market dominance, great financial stability or some other factor. Procter & Gamble, for example, is an excellent company, with a current P/E of 21.7 and expected five-year annual earnings growth of 5.6%. The PEG in this case is 3.9 – relatively high, but maybe this stock always has a high PEG.
Also keep in mind that the PEG is only as accurate as the growth forecasts going into it. Estimates can easily vary from reality by a couple of percentage points.
PEG is a quick and easy way to value a stock. But if it were that easy to value stocks, we’d all be millionaires. Use PEG to gain a fuller picture of how much a stock costs and fill in the details with other study.
Evan R. Guido is the founder of Aksala Wealth Advisors LLC, a 2018 Forbes Next-Gen Advisors List Member, and Financial Professional at Avantax Investment ServicesSM. Evan heads a team of retirement transition strategists for clients who consider themselves the “Millionaire Next Door.” He can be reached at 941-500-5122 or eguido@aksalawealth.com. Read more of his insights at heraldtribune.com/business. Securities offered through Avantax Investment ServicesSM, member FINRA, SIPC. Investment advisory services offered through Avantax Advisory ServicesSM, insurance services offered through an Avantax affiliated insurance agency. 6260 Lake Osprey Drive, Lakewood Ranch, FL 34240.
This article originally appeared on Sarasota Herald-Tribune: EVAN GUIDO: PEG is a quick and easy way for assessing a stock's value
