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Stock Ideas Investors Daily Edge When Growth Comes to an End
Stock Ideas Investors Daily Edge When Growth Comes to an End 
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| When Growth Comes to an End |
| Tuesday, 29 January 2008 | ||||||||
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The price/earnings to growth (PEG) ratio is a great way to get a quick snapshot of a company’s value and growth prospects. Let me briefly tell you how it works and why it might not be such a good idea right now to give it as much weight as before. P/E tells you how many years it takes a company to accumulate earnings equal to the price of its total shares. If the price is a million bucks and earnings are $100,000, it would take 10 years (P/E = 1 million/100,000) for the company to pay off the value of its shares from its earnings. Okay, that’s P/E. Are you still with me? The “G” or “Growth” part of the ratio refers to estimated annual growth for the next five years. It’s a number that comes not from the company but from analysts following the company. These analysts are not infallible. It’s a best estimate. No more, no less. But in times of transition, these forward-looking numbers can be suspect. And as we move into a recessionary period, many growth estimates for companies haven’t caught up to the reality of a slowing market. Let me give you an example of how PEG might mislead you. A P/E of 12 and a growth estimate of 12 percent yields a PEG of 1 (P/E divided by growth). A PEG of one (or lower) is very good. But what if the growth estimate is too high? What if six percent is more realistic than 12? The company’s PEG would spike to 2, which is unimpressive. The smart contrarian play is to take a second look at the low P/E and growth companies. A company with a P/E of seven (anything below 10 is considered good value) and a growth estimate of five percent a year may be appealing because as a “value” company, its slow growth is already built into the price of the company. Slower growth shouldn’t hurt it as much as when a “growth” company slows down. And if it can manage to meet its modest growth expectations, it’s ahead of the game and its share price could rise. In other words, value looks like a better deal than growth right now. P.S. To let me know what you thought of today's article, send an e-mail to: This e-mail address is being protected from spam bots, you need JavaScript enabled to view it
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