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

Equity Research

I was motivated to write this article because I had been googling a lot of ER stuff online; to no bliss. Therefore, I am writing one which would be easier to understand. In this article I shall talk about Equity Research.

Equity Research is a department that works for a brokerage firm, Investment Bank, Pension Fund. It is a revenue producing group that a firm owns. Their job is to figure out which sector, industry, company, share will be outperforming or should be sold off. They generate information necessary for the firm to decide how to allocate their funds.

BUY SIDE and SELL SIDE:

Sell Side Analysts often work for a brokerage firm and give *blanket recommendations* to mass clients. They are not answerable to the clients; but the firm they work for. This could also mean that he might give trade signs to benefit the firm than the clients; as any sell/ hold/ buy movement benefits the firm (trading commission).
Good models and financial estimates have more value to a Buy-Side Analyst because they are chosen by their work and research. They have a lot of pressure to be right, give good fund suggestions. They usually work for Pension Funds or Mutual Fund firms and give right stock recommendations.

Calculating a share's attractiveness: 

• Industry Overview
• Company Fundamentals
• Company Business
• Key Strengths
• Key Financial Indicators
• Peer Group Performance
• P/E Ratio

P/E Ratio:

Take for example, Facebook. So Facebook's Share price (as on 6th April 2014) is $56.75
You can just search the EPS of a company from search engines, if you dont want to calculate it. It's EPS (earning per share) is 0.61.
Therefore, P/E Ratio of Facebook is Share Price/EPS, viz, 56.75/.61
= 93.03

P/E Ratio is of no use unless you compare the same with P/E Ratios of other competitors.
There's argument to whether low P/E Ratio is good or high; but don't forget Warren Buffet made fortune by finding shares with low P/E Ratio and investing in them. This is also called Value Investing.

Future of an ER Analyst:

Once you have worked as an ER Analyst, you are skilled to analyze a share. You can fit well as a Wealth Manager later or with any other buy-side firms.

So much for today, will keep writing!