OPPORTUNITIES: Is PEG LeadingYou Astray?

Stambovsky, Jeff

Is PEG LeadingYou Astray? OPPORTUNITIES BY JEFF STAMBOVSKY We're not talking about some sloe-eyed vamp from the marketing department, but our PEG can also lure you off the true path, and cost you...

...Spectator readers who use this information for investment decisions do so at their own risk...
...So P/E is too vague...
...Atmel (ATML: 9 11/32 in early April...
...The true measure of the present value of a company's stock requires the appropriate discount factors (denominators) applied to the company's cash flows from here to eternity...
...ABC is an old-economy manufacturer that earned a dollar per share in the last twelve months and whose stock is trading at 15...
...Most models that I've seen stop well short of that, but it's nonetheless true that the further out in time that your model projects, the less effect that those period-ending stab-in-the-dark variables (like that 5year-out P/E) will have...
...So an unchanged P/E will require an exponential change in P that corresponds with the growth rate...
...PEG is the acronym for a ratio that's the latest fad in onedecision investment metrics...
...Now if you're a value investor comparing P/E ratios, ABC wins hands down...
...Keep in mind, though, that when you tell me that your Ferrari does zero-to-sixty in 4.6 seconds compared to my Camaro's 4.9, you haven't told me a lot about why yours is the better car...
...PEG:.66) is the world's dominant manufacturer of optical fiber, and has over the last few years become a photonics-components juggernaut in its own right, competing with industry giant JDS Uniphase...
...Either way, if you can't make a reasonably accurate forecast of that ending P/E, then PEG isn't going to help you choose between rival investments...
...If you use it as a screening device, PEG can help you to weed out stocks that appear to be enormously overpriced ("appear" being the operative word) as long as you remember not to compare fast-growing apples to slow-growing oranges...
...Corning (GLW: 20.74 in early April...
...Not necessarily...
...Therefore, P is always going to grow faster for the stock with the higher growth rate if the P/E ratios are projected to remain unchanged...
...Two low PEG stocks that are also attractive for other reasons are Corning, the world's dominant manufacturer of optic fiber, and semiconductor designer Atmel...
...The author may hold positions in stocks discussed in this column...
...Analysts figure XYZ should be able to show 50 percent annual earnings growth over the next five years...
...Obviously, that can't be the whole story because earnings will change over time-either for better or worsewhich is why many investors adjust the P/E to take into account the company's growth rate by turning it into PEG...
...And if you can, then you don't need PEG in the first place...
...but PEG is positively misleading...
...A survey of analysts reveals that ABC's expected earnings growth rate for the next five years is 10 percent per annum, giving it a PEG of 1.5...
...PEG: .51) is a leading semiconductor designer, with market-leading positions in memory chips and fabrication processes involving exotic materials like Silicon Germanium...
...The P/E ratio itself is nothing to write home about...
...XYZ's seemingly rich P/E could actually expand relative to the "value" P/E now sported by ABC...
...And there's the rub: The ending P/E is almost surely not going to be the same as today's P/E...
...Our two companies have the same PEG...
...More important, it conveys nothing about the dynamics of growth that give real meaning to valuations...
...Growth, PEG's denominator, is exponential...
...XYZ's PEG, then, also equals 1.5...
...If you're still hooked, here are two low PEG stocks that are also attractive for other reasons...
...well, not much...
...That is, since E (by definition) grows at the growth rate, P will have to grow at that rate as well if P/E is to be kept constant...
...it could also shrink...
...it will, in fact, depend greatly on the company's expected growth rate in five years, which could very well be different from its expected growth rate today...
...It's a static, simplistic, backward-looking number whose denominator is an accounting construct...
...does that tell us anything useful...
...Sure, it's popular in the lingua franca of portfolio management, and when used judiciously it can help us to communicate some very basic information...
...Take two companies, ABC and XYZ...
...Here's why...
...Because you'll get back your purchase price in earnings in fifteen years rather than the 75 that it'll take XYZ to earn it back for you...
...It stands for price-earnings growth...
...The problem with our example lies in the assumption of a static P/E...
...In its attempt to overcome the most basic shortcoming of P/E-the failure to consider a company's rate of growth-PEG adds mathematical sophistry to Generally Accepted Accounting nebulosity...
...XYZ is a fiber-optics components company that also earned a dollar last year, but its stock is trading at $75...
...66 THE AMERICAN SPECTATOR  May 2001...
...So should you dump PEG...
...The tradeoff is that the further out you go, the more uncertain your projections are likely to be and the more blindly you're stabbing.You can't have everything...
...OPPORTUNITIES BY JEFF STAMBOVSKY We're not talking about some sloe-eyed vamp from the marketing department, but our PEG can also lure you off the true path, and cost you quite a bit as well...
...Divide the old standby price earnings ratio by the expected growth rate, and you've got...

Vol. 34 • May 2001 • No. 4


 
Developed by
Kanda Sofware
  Kanda Software, Inc.