Message Font: Serif | Sans-Serif
 
UnThreaded | Threaded | Whole Thread (3) | Ignore Thread Prev | Next
Author: yatdave Add to my Favorite Fools Ignore this person (you won't see their posts anymore) Number: of 2003  
Subject: The PEG - a legitimate measure? Date: 4/23/2000 6:00 PM
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Recommendations: 2
I read about the PEG/Fool Ratio both here online in the Fool's School and in Tom & David Gardners' book "TMF Investment Guide." Both accounts explain that the ratio is based on the "accepted" principle that the P/E ratio of a company should equal the percentage of its growth rate. But neither account explains the rationale behind this "accepted" principle. I find the account in the book particularly disturbing. It reads:

"The technical underpinnings of the theory have something to do with anticipated cash flows looking years ahead, but the actual principle itself has melted away over the years. It's now become a generally accepted investment principle. It's actually kind of like the NFL's quarterback rating; nobody really knows the formula but everyone takes it for granted." (p.173)

To use a particular criterion for investing without actually understanding it sounds decidedly unFoolish, IMO. Blindly using numbers without understanding the basis of where they come from is downright dangerous. Besides, isn't that exactly what this site teaches people *not* to do?

On the surface, I can see no obvious direct relationship between the P/E ratio and growth rate.
Yes, it does make some intrinsic sense that as the projected rate of growth of a particular stock increases, the price that you should be willing to pay for that stock should also increase to some degree. So far, so good. But rather than being a vague conceptual statement, the principle behind the Fool Ratio is very specific. And it's the specifics of this principle that sound suspect to me. By this principle, a company with a 20% growth rate should be expected to have a P/E ratio of 20. Expressed in other words, if a company's value is expected to grow by a factor of 1.2 over a given length of time, the current value of the company should be expected to be 20 times its earnings. Does that sound logical to anyone? Sounds like mumbo-jumbo to me - at least on the surface anyway. I'm sure there is a good, logical explanation of it all, but it certainly isn't an obvious one.

I've tried searching this site, as well as the book, to find a better explanation of the above-stated principle, but haven't found a thing. If it's out there and I've missed it, could someone please point me to it? If it's not, could anyone provide an explanation or a demonstration of its validity? In the meantime, I have a hard time considering the Fool Ratio a legitimate analytical tool simply b/c someone says, "It works - trust us."

Suspicious but curious,
yatdave
Post New | Post Reply | Reply Later | Create Poll . Report this Post | Recommend it!
Print the post  
UnThreaded | Threaded | Whole Thread (3) | Ignore Thread Prev | Next

Announcements

Pencils of Promise - Back to School Drive
"Pencils of Promise works with communities across the globe to build schools and create programs that provide education opportunities for children."
Post of the Day:
Berkshire Hathaway

IBM: Is Buffett Wrong, or Brilliant?
What was Your Dumbest Investment?
Share it with us -- and learn from others' stories of flubs.
When Life Gives You Lemons
We all have had hardships and made poor decisions. The important thing is how we respond and grow. Read the story of a Fool who started from nothing, and looks to gain everything.
Community Home
Speak Your Mind, Start Your Blog, Rate Your Stocks

Community Team Fools - who are those TMF's?
Contact Us
Contact Customer Service and other Fool departments here.
Work for Fools?
Winner of the Washingtonian great places to work, and "#1 Media Company to Work For" (BusinessInsider 2011)! Have access to all of TMF's online and email products for FREE, and be paid for your contributions to TMF! Click the link and start your Fool career.
Advertisement