P/E RATIO OR PEG RATIO?

(Just a revision : What is P/E RATIO -> Share Price/Earning per share

PEG Ratio -> P/E Ratio/Growth Rate)

I was asked today why modern analysts give so much importance to the PEG ratio? I reckon its because as P/E Ratio, on one hand, only tells us how much an investor is willing to pay for each dollar extra earned on the investment; 

PEG Ratio, on the other hand, tells us whether the stock is over-valued or under-valued. It takes future (growth) in account.

While P/E is historical (as it judges on the earning earned and market share price), PEG Ratio is futuristic; and if you are in the markets, you must buy the future.

Although today when I was re-studying P/E Ratio and PEG Ratio, I stumbled upon some very interesting articles on the net where they have said that PEG Ratio is a silly tool. I am surprised at their arguments, nevertheless Its safe to say that PEG Ratio is a safe tool, provided you are valuing “teenager” stocks, i.e., stocks that have not matured yet and are growing.

I understand it’s a little mind-stressing as to come to the ratio, you first have to evaluate P/E Ratio… now what PE Ratio do you use? Forward or Trailing?

And then Growth Rate – forward or trailing? 1 year or more or more? And if you want to verify your ratio with other online sites, then, trust me, it’s like finding marijuana in your Lucky Strike packet of cigarettes; chances are 1:100!

So, what’s the solution? Now that is something none of the investors mentioned in their articles! Yes, perfect.. tell us this valuation tool is flawed too.. and have people run to you like you are the Intelligent Investor, or ask to subscribe to your solution booklet for $99. Well, you are a cynic finding faults in anything discovered and making money out of your cynicism. Don’t go around breaking bubbles!

The solution is instead of being in a rush to disapprove and strike out all available valuation tools, we must know why they were derived in the first place, and how to use one, especially where to! 
So, when finding PEG, take current P/E Ratio (If you don’t want to use the formula, its available on http://www.nasdaq.com/symbol/fb/pe-ratio). 

Growth Rate - Now it depends, I tend to use the 5 years one cuz it irons out the creases of time and volatility, Use this site as it gives Growth Rate for both Trailing and future 5 years http://hotstocks.mygroupmedia.com/PEG.aspx

Use the lowest future Growth rate (and EPS) than given, so you are being risk-proof.

Another thing to keep in mind is the lesser the PEG Ratio, the better. It is like ladder rungs; the higher the PEG Ratio, the further you can fall and more you can get hurt.

So, what about Stocks that have matured? With 0 growth?

The formula by Graham in 1962 for stock valuation (with adjustments):

Value = EPS x [8.5 + (2 x Growth Rate) x (4.4/5.76)]

*4.4 the rate of return used then, and divided by 5.76 is the adjustment made.

Now, we will take example of GOOG. I am taking values from the above mentioned sites:

Value = 31.91 x [8.5 + (2 x 13.45) x (4.4/5.76)]

             = $ 926

Adjustment made:

Value = 31.91 x [7 + (1.5 x 13.45) x (4.4/5.76)]

                =$ 715

(This seems more real) and GOOG is currently trading at around $556, so it is currently undervalued.

And if valuated by the basic PEG Ratio formula, even then 1.3 is a very good ratio.

PEG Ratio	P/E Ratio	Share Price	EPS	Growth Rate
1.29672324	17.4409276	556.54	31.91	13.45