PEG

[TheMotorcycleBoy]

Hi folks,

I just wanted to make a quick post about PEG. Apologies for my brevity, but am currently on my lunch break. So as I'm already aware, PEG is the ratio of P/E over EPS growth. But what I'm unclear over is the EPS growth figure to use....should one use the CAGR of EPS over the past 5 years or so, or just the growth over the last year.

As an example I've got these figures for Bodycote Plc (BOY) just quickly grabbed from here: http://financials.morningstar.com/ratio ... ture=en-US



So as can be seen the PEG ratio, differs from either suggesting BOY are "not that cheap" to "an amazing bargain". So what do people here think? What's the low down on PEG calculation?

Out of interest my curiosity was aroused as, I was looking at the "sharesmagazine" site at something unrelated, and then ended up on https://www.sharesmagazine.co.uk/shares/share/BOY and upon seeing the proclaimed low PEG for BOY according to this site, I decided to investigate further.

All comments appreciated,
Matt

[SalvorHardin]

There is no correct answer. Some people use the average of the last three or five years, I've seen some using just the previous year (a method which produces an exaggerated PEG ratio).

One thing to be careful about is that you should remove exceptional items (one-offs) when calculating EPS. Things such as profits generated by business sales can greatly increase EPS which in turn messes up the PEG ratio. Also be careful when looking at property companies as you may wish to treat property revaluation profits as one-offs (that's what I do). even though they don't appear in exceptional items.

If EPS growth > PE that's good enough for me to get interested!

[TheMotorcycleBoy]

There is no correct answer. Some people use the average of the last three or five years,

Thanks Salvor, kinda what I'd thought.

I've seen some using just the previous year (a method which produces an exaggerated PEG ratio).

Yes, I guess that's what was occurring with the Bodycote example that I used in my OP.

One thing to be careful about is that you should remove exceptional items (one-offs) when calculating EPS. Things such as profits generated by business sales can greatly increase EPS which in turn messes up the PEG ratio.

Thanks, good tip.....In fact on that note I decided to look in Bodycotes AR for 2017. No disposals, but the EPS boost can be plainly seen as a combination of a sales bump, and since a lot of their business is state side, the reduction in tax for that year due to DJT's corporate handout:

Summarised here:


Page 85 here https://www.bodycote.com/wp-content/upl ... t-2017.pdf

If EPS growth > PE that's good enough for me to get interested!

Sure, the magical PEG < 1.

From what you've shared it looks like the key is to, perhaps, look over the last few years, and if you see an EPS jump, further investigation is required.

Many thanks for inspiring me to look further!
Matt

[MaynardPaton]

So as can be seen the PEG ratio, differs from either suggesting BOY are "not that cheap" to "an amazing bargain". So what do people here think? What's the low down on PEG calculation?

The growth rate used as the PEG denominator ought to be your best guess as to the 'sustainable' future EPS growth rate for the company.

You can look at the past to judge how EPS has fared for guidance, but the share-price rerating -- which is what you are trying to capture with a sub-1 PEG -- will only come through future EPS growth. A judgement call is needed -- there is no set formula for determining the 'sustainable' rate of future EPS growth.

Jim Slater's Zulu Principle books from the 1990s are worth reading to learn more about the PEG. The best PEG shares are typically smaller companies growing at 15%-20% pa, with P/Es of 10-15. Hunting for such shares has been generally fruitless during the last 20 years as Jim popularised the PEG and everybody now knows the methodology. Also, the market has prized growth shares highly during this period of QE.

Where people, including me, went wrong with PEGS back in the day was misjudging the 'sustainable' part of the equation. Companies could produce a good few years of EPS growth, but could not maintain such advances as either the economy, greater competition or some internal company mishap derailed the EPS record. Thinking about whether a company can first sustain EPS advances is vital, and should be undertaken before considering the PEG.

Maynard

[TheMotorcycleBoy]

Jim Slater's Zulu Principle books from the 1990s are worth reading to learn more about the PEG. The best PEG shares are typically smaller companies growing at 15%-20% pa, with P/Es of 10-15. Hunting for such shares has been generally fruitless during the last 20 years as Jim popularised the PEG and everybody now knows the methodology. Also, the market has prized growth shares highly during this period of QE.

Yes. His books are on my list. My birthday is tommorow, so perhaps the wife/kids have treated me

Where people, including me, went wrong with PEGS back in the day was misjudging the 'sustainable' part of the equation. Companies could produce a good few years of EPS growth, but could not maintain such advances as either the economy, greater competition or some internal company mishap derailed the EPS record. Thinking about whether a company can first sustain EPS advances is vital, and should be undertaken before considering the PEG.

Yes, I've wondered how exactly the PEG formula breaks down as EPS growth subsides. I'm pretty sure that Benjamin Graham was already onto this. Indeed I believe that there is a formula in "The Intelligent Investor" in which growth and PE for non-growth firm are somehow incorporated. [*]

I may have my wires a little crossed, as I'm a relative newbie, but I did start writing something about this in another thread. I'm planning on visiting this soon, possibly with my own version.

Matt

[*] PEG could do with enhancement.