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Author: RichSK Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2003  
Subject: How To PEG Fool Ratio Date: 2/24/1999 12:14 PM
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Because a lot of people seem to be having trouble in computing the Fool Ratio, I hope this "cookbook" will be of some help.

For the following:
P = Price per share

E = Earnings per share in the last twelve months (Trailing Earnings)

G = Average Annual Growth in earnings

F = Earnings per share in the future (Forward Earnings, predicted by analysts)

T = Time into the future (in years) that "F" (the Forward Earnings) refers to

The Fool Ratio begins with this premise:
"In a fully and fairly valued situation, a growth stock's price-to-earnings ratio should equal the percentage of the growth rate of its company's earnings per share."

The above translates into this math:
P/E = G

Where the "/" means "divided by" - "P/E" means "P divided by E". Note that "P/E" is the price-to-earnings ratio.

The Fool Ratio then is:
Fool Ratio = (P/E)/G

"In a fully and fairly valued situation,..." the Fool Ratio equals one.

When the share price is too high, the Fool Ratio is much greater than one.

When the share price is too low, the Fool Ratio is much less than one.

To find "G":
G = 100 * ((F/E)^(1/T) - 1)

Where the "*" means "multiplied by" or "times" - "100 * 5" means "100 times 5"; the "^" means "raised to the power of" - "2^3" means "2 raised to the power of 3".


If T = 1 year, then:
G = 100 * ((F/E)^(1/1) - 1), or
G = 100 * ((F/E)^(1) - 1), or
G = 100 * ((F/E) - 1)

If T = 1 quarter = 3 months = 0.25 year, then:
G = 100 * ((F/E)^(1/0.25) - 1), or
G = 100 * ((F/E)^(4) - 1), or
G = 100 * ((F/E)*(F/E)*(F/E)*(F/E) - 1)

If T = 2 years, then:
G = 100 * ((F/E)^(1/2) - 1), or
G = 100 * (Square_Root(F/E) - 1)

If T = 3 years, then:
G = 100 * ((F/E)^(1/3) - 1), or
G = 100 * (Cube_Root(F/E) - 1)

If T = 1 year and 6 months = 1.5 years, then:
G = 100 * ((F/E)^(1/1.5) - 1), or
G = 100 * ((F/E)^(2/3) - 1), or
G = 100 * (Cube_Root((F/E)^(2)) - 1), or
G = 100 * (Cube_Root((F/E)*(F/E)) - 1)

Example based on http://www.fool.com/School/TheFoolRatioExplained.htm:

"Maui Joe's Luau Supplies (NASDAQ: HULA) is a tiny niche company with a highflying stock that over the past 6 months has tripled to its current level of $9 per share. Having called the company and obtained the only up-to-date report by any analyst (which took a fingernail-extracting three weeks to arrive in the mail), you first learn that Maui Joe's EPS over the past 12 months has been $0.50. Which makes the P/E ratio 18. You furthermore discover that the analyst projects Maui Joe's to have earned 75 cents per share a year from now. And $1.15 the year after."

P = 9
E = 0.50
P/E = 9/0.50 = 18

Fool Ratio = (P/E)/G = 18/G

"Well, we already have the P/E. We need the growth rate. 'Calculator on,' you vocalize, powering up your trusty sidekick. Lightning fast, you repeat the steps you learned above, coming up with 52% (rounded) for your 2-year annualized growth rate."

F = 1.15
T = 2

G = 100 * ((F/E)^(1/T) - 1)
= 100 * ((1.15/0.50)^(1/2) - 1)
= 100 * (2.3^(1/2) - 1)
= 100 * (Square_Root(2.3) - 1)
= 100 * (1.51657508881 - 1)
= 51.65750888103, or about 52.

Fool Ratio = 18/52 = 0.3461538461538, or about 0.35.
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