ShmoopTube

00:00

Finance Allah shmoop what is priced toe earnings to growth

00:06

or a peg ratio You know what the P E

00:10

ratio is right And if you don't I'll check out

00:12

our fine opus on said Subject Here it's him up

00:15

So price here's build a bore Stock trading at forty

00:19

bucks a share It had net income or earnings last

00:22

year of two bucks a share in trades at yes

00:24

twenty times earnings So that's a P and in hee

00:28

price and in earnings there it trades at twenty times

00:31

earnings Um yeah So what does that mean Well if

00:36

it held the earnings flat and basically all of its

00:38

earnings was cash earnings Not like some fancy accounting trick

00:42

Well if earnings were flat for twenty years well the

00:45

company would have made back all of its valuation in

00:48

cash profits and everyone would yawn right Twenty years at

00:52

two bucks a year twenty times two is forty right

00:54

Well that company would have paid up five percent cash

00:57

return yield Right Two bucks in earnings over forty bucks

01:00

a share to over forty in California and in Texas

01:04

is five percent So is that a good return about

01:06

return Was there a lot of risk in that number

01:08

Growth shrinkage Wealth in a peg ratio Earnings growth is

01:13

taken into consideration when evaluating the ratios of a stock

01:17

So twenty times earnings is kind of a ho hum

01:19

multiple But this company has no growth so that twenty

01:22

times is probably a pretty high multiple as a multiple

01:25

You know all things considered like twenty years a long

01:28

time to get all your money back What if earnings

01:30

were doubling each year for the next five years Like

01:32

earnings went from two to four to eight to sixteen

01:35

to thirty two bucks a share Well then twenty times

01:37

earnings was ludicrously cheap Growth was one hundred percent versus

01:42

that zero percent where twenty times earnings Look you know

01:45

decent Well the basic idea and this one is coined

01:47

by Peter Lynch the famed portfolio manager who brought Fidelity

01:51

to fame Is that a peg ratio of one means

01:54

that a stock is basically fairly priced that is P

01:57

E ratios need contexts specifically the context of earnings growth

02:02

The formula takes the P E ratio say it's a

02:04

twenty and then puts it over the annual earnings per

02:08

share growth number and note that it's per share not

02:11

just overall company earnings Like if a company grew earnings

02:15

by acquiring for stock a lot of competitors well it's

02:18

share count would balloon While it's earnings grew fast as

02:21

well but likely the dilution and suffered would mitigate most

02:25

of the upside in earnings growth So on our twenty

02:27

times earnings number a company with no growth gives us

02:30

a peg ratio of twenty over zero which is an

02:34

undefined number But peg ratio is all about how expensive

02:38

the price to earnings ratio is relative to the growth

02:41

of the company Wow we did not see that plot 00:02:45.65 --> [endTime] twist coming yellow

Full Transcript