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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,
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