Friday, June 22, 2007

Improved Version of the PEG Ratio

In a previous article, we used the PEG ratio to evaluate a stock. While the PEG ratio is a good method, I've decided to create my own variation of the PEG ratio which I'll call MyPEG.

The Formula is this:

MyPEG = ((Current Price - Cash Per Share) / Forward Earnings) /
(Yield + 5 Yr Estimated Growth Rate).

What this does is take into consideration the dividend yield of a stock. It also takes into consideration how much cash is in the stock. As legendary investor Peter Lynch said, by taking cash per share into the equation, we might be able to find great bargains out there.

We will still use MyPEG the same way as PEG. A MyPEG < 1 means the stock is cheap, while a MyPEG > 2 is very expensive. We can compare stocks using MyPEG, but it's better to compare stocks in the same industry.

How to find the numbers through Finance.Yahoo.com

Go to Finance.yahoo.com and enter your stock symbol. You get a nice summary page with basic information and news. A very useful page is the Key Statistics Tab.

You can find this information there:

  1. Market Cap: Top Part of Page
  2. Trailing PE: Top Part of Page
  3. Forward PE: Top Part of Page
  4. Price: Very Top of Page
  5. Cash per Share: Bottom Left side under Balance Sheet.
  6. Yield: Lower right corner under Dividends and Splits

Another useful tab is the Analysts Estimates Tab.

You can find this information there:

  1. Trailing 12 months Earnings: Top part of Page, look at Year Ago EPS under Current Year (Dec-07).
  2. Current Year Earnings: Top part of Page, look at Avg. Estimate under Current Year (Dec-07).
  3. Future Earnings: Top part of Page, look at next Year, Avg. Estimate


So to calculate the MyPEG of General Electric (GE):

MyPEG = ((Current Price - Cash Per Share) / Forward Earnings) /
(Yield + 5 Yr Estimated Growth Rate).


  1. Current Price (June 22, 2007): 38.24
  2. Cash Per Share: 1.872
  3. Forward Earnings: 2.49
  4. Forward Yield: 2.90%
  5. 5 Yr. Estimated Growth: 10%



MyPEG = ((38.24 - 1.872) / 2.49) / (2.9 + 10)
= 1.13


Note regarding Banks and Brokers

You shouldn't use items like Cash Per Share in companies such as Banks or Brokers. It won't be accurate. Just see the Cash Per Share of Goldman Sachs (GS): 1,769. Not a valid number to use in the MyPEG formula.

Credits

I came up with adding Yield to the 5 Yr. Growth Rate by myself. I was inspired to use the cash per share method by reading Peter Lynch's One Up On Wall Street : How To Use What You Already Know To Make Money In The Market, an excellent book. I definitely recommend it. (Other Book Recommendations in the link or to the section to the right).

I combined both methods and created the MyPEG.

Note on PEG and Growth Rates

In other posts such as this analysis of Computer and Video Game Stocks, I often put in this section regarding PEG and Growth Rates because Growth Rates are estimates and may not be as reliable:

"When choosing between a stock that has a PE of 15 and a growth rate of 15% vs. a stock that has a PE of 30 and a growth rate of 30% (both have a PEG ratio of 1), I'll prefer the former. The reason is that high PE's are often priced to perfection. Any miss and high PE stocks can get hit very hard. Stocks with Lower PEs have less expectations and have a greater margin of safety. Another reason is that I have more confidence in the forward PE than the 5 yr. estimated growth rate. So the results are better by preferring the lower PE stock given an equivalent PEG or MyPEG because the 5 year growth rate is given less importance. Lastly, stocks can't maintain 30% plus growth for long periods of time, so growers from 15-30% might be preferred."

7 comments:

Anonymous said...

Isn't this a bit more speculative given the fact that you can only roughly predict 5 year growth trends?

techfarmer said...

Excellent question! I modified the last section of this post with additional information.

When calculating PEG (the basic form), we have PE/5 yr Growth Rate. And as you say, how reliable is this when the 5 yr Growth rates are just estimates.

I say, excellent point. So if two stocks have the same PEG, I would prefer the stock with the lower forward PE, ideally, a forward PE under 20. This way, there is less risk. The forward Earnings estimate are more accurate than the 5 yr estimate. If a stock had a high PE (with equivalent PEG), there is much more risk. But if the stock has a PE of less than 20, then there is greater safety.

One method I like is to choose stocks with a forward PE of less than 20, and a 5 yr growth rate of more than 20. We are guaranteed to have PEG of 1 or less, plus, the forward PE is low. You would have chosen have a low risk growth stock.

Anonymous said...

"One method I like is to choose stocks with a forward PE of less than 20, and a 5 yr growth rate of more than 20. We are guaranteed to have PEG of 1 or less.."

Would you be keen to do a list of stocks (in the bull sectors) that meet your criteria above?

techfarmer said...

Good request regarding current screen. I might just do a scan of the entire market (not just in the "Bull Markets").

In the meantime, here's one good screen I use which uses this:
http://techfarm.blogspot.com/2007/07/cheap-growth-ready-to-breakout-screen.html

And the results of three portfolios which used this screen:
http://techfarm.blogspot.com/2007/07/results-of-3-portfolios-cheap-growth.html

Niznusan said...

So if Im doing this right, Dyncorp (DCP) would have a MyPeg of .96?

techfarmer said...

Niznusan:

Great job on the calculation.

This is based on:
Price on 7/26: $21.19
Cash Per Share: 1.797
Earnings: 1.32
5 Yr Growth: 15.36%

For MyPEG = 0.96

You are right.

I haven't given people a hint on this one yet. On yahoo finance, look at the tab on the left (once you are looking at a stock), and look at the competitors tab. Look at competitors of your company, and calculate the MyPEG of those companies. It will help you analyze the companies.

Here's a sample analysis:
Health Care Insurers
Drink and Sodas

techfarmer said...

Forgot to add that DCP has a yield of 0%.