Will the Real PEG Please Stand Up?
Growth investors traditionally think differently from deep value investors, as the share price of growth shares diverge, often radically so, from the asset value of the company. True deep value investors aren’t really too concerned about a company’s PEG, as this figure is primarily derived from exceptional future earnings expectations.
However in today’s market, where value becomes more difficult to find, it might pay to include a low multiple growth stock or two in your portfolio.
Growth investors utilize the PEG ratio to estimate the value of the price that they are paying for a company. The basic rule of thumb is that a PEG of less than .6 is worth buying and a PEG of .6 or over is not. As always, the other elements of the safety net, such as a low multiple, director purchases, a lack of major director selling, strong cash flow, strong liquidity, etc., should be in place.
Unfortunately investors often take a short cut when calculating the PEG ratio, taking only the year-end EPS figures and the relevant growth rates.
For example, they might use the December year-end figures for the current year in their calculations when analyzing the company in at the beginning of May that same year.
Another example is when two companies with different year ends are compared using their respective year-end figures. Obviously if one company has a year end in June and another company has a year end in December, this approach does not make sense.
Let’s take a look at the earnings and earnings growth of London listed Sprue Aegis (SPRP), a rather illiquid small cap which recently delivered super 2010 preliminary results.
The 2010 actual results and other forecasted EPS are shown in the following table:
Currently the offer price is 80 pence per share.
To calculate the true EPS for the next year we must calculate it from the start of May, 2011.
Therefore our calculation looks as follows:
(7.8 X 8/12) + (10.9 X 4/12) = 8.83
The 8/12 figure represents the remaining months left in 2011 whilst the 4/12 figure represents the first four months of 2012, giving us an EPS figure from May 1, 2011 to April 30, 2012.
Now we can calculate our true P/E by dividing the share price of 80p by our EPS figure of 8.83, giving an answer of 9.06.
The growth rate for the next year is also easy to calculate.
We must calculate the EPS for the previous year first as follows:
(6.5 X 8/12) + (7.8 X 4/12) = 6.93
We can calculate EPS growth as follows:
8.83 Less 6.93 = 1.9
1.9 / 6.93 = 27.42% growth
Finally we can calculate the true PEG as follows:
9.06 / 27.42
This gives a PEG of .33 which is well below the borderline figure of .6
Given that the P/E is still only in single figure, it makes SPRP a very attractive growth share indeed.
Disclosure: I hold SPRP Shares
I am a partner at www.shareladder.com where I write the newsletter. Currently the portfolio constructed from the newsletter is up 42% over the last year. The investment principles I follow are mainly derived from the Benjamin Graham school of investing.
Growth investors traditionally think differently from deep value investors, as the share price of growth shares diverge, often radically so, from the asset value of the company. True deep value investors aren’t really too concerned about a company’s PEG, as this figure is primarily derived from exceptional future earnings expectations.
However in today’s market, where value becomes more difficult to find, it might pay to include a low multiple growth stock or two in your portfolio.
Growth investors utilize the PEG ratio to estimate the value of the price that they are paying for a company. The basic rule of thumb is that a PEG of less than .6 is worth buying and a PEG of .6 or over is not. As always, the other elements of the safety net, such as a low multiple, director purchases, a lack of major director selling, strong cash flow, strong liquidity, etc., should be in place.
Unfortunately investors often take a short cut when calculating the PEG ratio, taking only the year-end EPS figures and the relevant growth rates.
For example, they might use the December year-end figures for the current year in their calculations when analyzing the company in at the beginning of May that same year.
Another example is when two companies with different year ends are compared using their respective year-end figures. Obviously if one company has a year end in June and another company has a year end in December, this approach does not make sense.
Let’s take a look at the earnings and earnings growth of London listed Sprue Aegis (SPRP), a rather illiquid small cap which recently delivered super 2010 preliminary results.
The 2010 actual results and other forecasted EPS are shown in the following table:
Year End | EPS ( Pence ) | EPS Growth ( % ) |
Dec 2010 | 6.5 | 45.8 |
Dec 2011 | 7.8 | 18.9% |
Dec 2012 | 10.9 | 39.6% |
Dec 2013 | 14.6 | 34.1% |
Currently the offer price is 80 pence per share.
To calculate the true EPS for the next year we must calculate it from the start of May, 2011.
Therefore our calculation looks as follows:
(7.8 X 8/12) + (10.9 X 4/12) = 8.83
The 8/12 figure represents the remaining months left in 2011 whilst the 4/12 figure represents the first four months of 2012, giving us an EPS figure from May 1, 2011 to April 30, 2012.
Now we can calculate our true P/E by dividing the share price of 80p by our EPS figure of 8.83, giving an answer of 9.06.
The growth rate for the next year is also easy to calculate.
We must calculate the EPS for the previous year first as follows:
(6.5 X 8/12) + (7.8 X 4/12) = 6.93
We can calculate EPS growth as follows:
8.83 Less 6.93 = 1.9
1.9 / 6.93 = 27.42% growth
Finally we can calculate the true PEG as follows:
9.06 / 27.42
This gives a PEG of .33 which is well below the borderline figure of .6
Given that the P/E is still only in single figure, it makes SPRP a very attractive growth share indeed.
Disclosure: I hold SPRP Shares
I am a partner at www.shareladder.com where I write the newsletter. Currently the portfolio constructed from the newsletter is up 42% over the last year. The investment principles I follow are mainly derived from the Benjamin Graham school of investing.
