Price/Earnings Growth (PEG) – 2

Regarding to Price/Earnings Growth (PEG), after further study, I found new flaws in this ratio.

I believed that the PEG ratio is too simplistic (flawed) and does not do justice to capturing the risk differentials between industries and stocks. It assumes a linear relationship between P/E and earnings growth. The PEG aficionado is looking to buy stocks with low PEG ratios. A 30% earnings grower trading at a P/E of 20 and a PEG of 0.66 (20 divided by 30) is more attractive than a stock trading at a P/E of 2 but growing earnings at 1% a year, resulting in a PEG of 2 (2 divided by 1). That did not seem logical to me.

Higher growth of earnings usually comes at higher risk; thus the relationship between P/E and a company’s growth rate is far from being linear,
and the PEG ratio doesn’t address this issue. In addition, the PEG ratio is focused solely on earnings and ignores dividends. On top of all
that, it assumes that a company that is not growing earnings is worthless (P/E divided by 0% growth = 0 value).

Advertisements

Leave a Reply

Fill in your details below or click an icon to log in:

WordPress.com Logo

You are commenting using your WordPress.com account. Log Out / Change )

Twitter picture

You are commenting using your Twitter account. Log Out / Change )

Facebook photo

You are commenting using your Facebook account. Log Out / Change )

Google+ photo

You are commenting using your Google+ account. Log Out / Change )

Connecting to %s