Monday, 20 July 2009

PE ratio, PEG and EPS Growth rates

A high PE ratio by itself means that either
  • the valuation is very expensive (where the stock price is high as compared to its EPS) or
  • it has such great potential for growth that investors are willing to accord it with a high PE ratio.

In general, the lower the PE ratio, the better it is.

For high growth stocks, we also look at the PEG ratio (PE ratio/ EPS Growth rate). For high growth stocks, their PE ratio if viewed on absolute basis is usually very high. How do we then decide if it is still "cheap" enough for us to hold or even buy? We use the PEG ratio to see whether its growth is at a faster rate as compared to its appreciation in value (i.e. high PE ratio). If PEG is low despite a high PE ratio, this would indicate the growth in earning (higher EPS growth) is much faster than the increase in its valuation (higher PER), and hence could justify our holding or even buying the stock.

1 comment:

PEGGY Method said...

I just posted the following in my blog

I hope it can be used in your blog as an investment tool. Thanks

Rather than just rely on PE ratio, or now the trend is PEG ratio, we also need to evaluate gearing and dividend yield. I try to make things easy for you all to remember, so I come out PEGGY method to evaluate a company.


PE is PE ratio. The lower the better.
G is Growth, expected long term growth rate eg 15%. The higher the better
G is gearing, the lower the better, best is net cash
Y is yield, ie dividend yield. The higher the better

All are important. More than 10 years ago I just look at PE, which is not enough.
Now people like to use PEG, that is using PE ratio divided by growth rate. The lower the better. But also not enough. Many don't bother about gearing.
Some investor just look at Dividend Yield.

You need to consider all. So, I advise you to use my PEGGY method
Just remember PEGGY, easy right.

If your remisier ask you to buy Genting International Ltd Singapore or IOI Corp, you can start asking him, what is the PE? Then ask him what is expected growth rate? How about gearing? Is dividend yield high?