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Thursday, September 13, 2007

The PEG Ratio

The price earning growth ratio is a variant of the price earning ratio.The information contained in PEG ratio is not very different from what can be derived from a properly calculate P/E Ratio.As a retail investor u are unlikely to calculate this urself,but if u can,u wil benefit from the insights.

PEG Ratio"s utilitylies in that it urges u to look forward.It is also somewht easier to interpret than the plain-vanilla P/E ratio.In mathemetical terms,it is calculated by dividing curent P/E ratio by expected earnings growth.

For example,lets assume calculating it for infy.Suppose the curent P/E for on consolidated 12 months trailing profit is 32 times.To calculate PEG,We nd to formulate growth expectations.For the moment lets take a cue from the numbers put out in broking reports.The expectation for a 12 month earning growth is around 28%.This gives a PEG of 1.14=32/28).The growth expectation over the next 2 years in broking report is similar,so the 2 year PEG is also 1.14.

The number 1 is in a way neutral rate for the PEG ratio.At this number,the P/E and earnings growth rate are perfectly matched.If the PEG ratio is less than 1,that means the earnings are growing faster than the P.E.In other words the P.E will fall next year if the price doesnt changes.

If the PEG ratio is more than 1,it implies that earnings are growing slower than the P.E.This means price will increase if P.E remains the same.The latter points to an unpleasant scenario.Incresing P/E means the stock is becoming more expensive.So holding on to a stok with a PEG ratio of more than 1 is certainly dangerous.So sud u continue to own a stock with a PEG of greater than 1?Identically no,unless u are short of better ideas.U may well ask now:Why doesnt a stock correct so that its PEG becomes lower than 1?There cud be various reasons.There may be other players in the market with a higher views of earnings growth of that company.Sometimes market gives premiums for management or pedigree qualities.Funds will hold companies like infy til its gets realy expensive,with a PEG of say 1.5 or more.

Some investors use the thumbrule of buying at PEG of around 1 or less for large companies and .5 or below it for smaller or midcap companies.Now i hope u ppl have understood the full aspect about this interesting PEG ratio.So why to delay:Go on and find out the expensive/inexpensive stocks in ur portfolio.


Regards,
ARUN

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