Pegging
Categories: Metrics
Pegging is not something from a prison movie, a Deadpool 2 joke, nor a global currency management strategy that grew out of Bretton Woods.
Instead, PEG actually stands for price-to-earnings-to-growth, and the term refers to when shareholders get paid back for taking risk in buying a high multiple (i.e. high price-to-earnings ratio) stock.
So...let's say you have a stock trading at 10 times earnings, where earnings should be flat the next decade. Well, you have 10 years to get all your money back, including dilution from stock options and other weird things that happen along the way. The PEG payback period is 10 years.
The reason that the PEG Payback Period even became a Thing is that, in bubbles, where companies are growing 100% a month for a while, investors pay 300x earnings or more, and that "insane" multiple makes old geezers scratch their heads and laugh about how stupid the investors are who are paying such a high multiple.
Well, Yahoo came public in the mid '90s at a valuation of about $260 million. It had $1 million in notional (i.e., kinda made up with a wink) earnings. So yes, it came public at 260x earnings. Insane, right? Well, in hindsight, just 3 years later it had earnings of about $260 million. So yes, it came public at 1 times 3 year forward earnings. Only one times earnings. How cheap is that? Well, you need to have a bit of vision, a bit of faith, hope, and of course prayer helps. But think about how all the old people who laughed at the Yahoo IPO as insanely expensive felt after the stock went up 300 times in value in 6 years? Yeah, take that, naysayers.
Anyway, the PEG Ratio series is all about rationalizing "insane" valuaitons with "insane growth," as some crazy, growthy things have happened in this internet era. Would anyone have guessed that the ant named Amazon in 1995 would end up destroying Walmart? Well, Jeff did. Not sure who else though.
Related or Semi-related Video
Finance: What is Price-to-earnings-to-gr...4 Views
Finance Allah shmoop what is priced toe earnings to growth
or a peg ratio You know what the P E
ratio is right And if you don't I'll check out
our fine opus on said Subject Here it's him up
So price here's build a bore Stock trading at forty
bucks a share It had net income or earnings last
year of two bucks a share in trades at yes
twenty times earnings So that's a P and in hee
price and in earnings there it trades at twenty times
earnings Um yeah So what does that mean Well if
it held the earnings flat and basically all of its
earnings was cash earnings Not like some fancy accounting trick
Well if earnings were flat for twenty years well the
company would have made back all of its valuation in
cash profits and everyone would yawn right Twenty years at
two bucks a year twenty times two is forty right
Well that company would have paid up five percent cash
return yield Right Two bucks in earnings over forty bucks
a share to over forty in California and in Texas
is five percent So is that a good return about
return Was there a lot of risk in that number
Growth shrinkage Wealth in a peg ratio Earnings growth is
taken into consideration when evaluating the ratios of a stock
So twenty times earnings is kind of a ho hum
multiple But this company has no growth so that twenty
times is probably a pretty high multiple as a multiple
You know all things considered like twenty years a long
time to get all your money back What if earnings
were doubling each year for the next five years Like
earnings went from two to four to eight to sixteen
to thirty two bucks a share Well then twenty times
earnings was ludicrously cheap Growth was one hundred percent versus
that zero percent where twenty times earnings Look you know
decent Well the basic idea and this one is coined
by Peter Lynch the famed portfolio manager who brought Fidelity
to fame Is that a peg ratio of one means
that a stock is basically fairly priced that is P
E ratios need contexts specifically the context of earnings growth
The formula takes the P E ratio say it's a
twenty and then puts it over the annual earnings per
share growth number and note that it's per share not
just overall company earnings Like if a company grew earnings
by acquiring for stock a lot of competitors well it's
share count would balloon While it's earnings grew fast as
well but likely the dilution and suffered would mitigate most
of the upside in earnings growth So on our twenty
times earnings number a company with no growth gives us
a peg ratio of twenty over zero which is an
undefined number But peg ratio is all about how expensive
the price to earnings ratio is relative to the growth
of the company Wow we did not see that plot 00:02:45.65 --> [endTime] twist coming yellow