Price-to-Earnings-to-Growth and Dividend Yield Ratio
Categories: Company Valuation
See: Price-to-Earnings-to-Growth Ratio. See: Dividend Yield.
A law firm that recruited too many partners? A really boring double play combo?
Actually, it's a way to track how a company gets valued by the equity markets. The basic measure of valuation is called price-to-earnings ratio (also known as the P/E ratio). That figure takes a company's stock price and compares it to the amount the firm posts in earnings. The higher the ratio, the more the stock purchaser has to pay for the earnings the firm produces. The higher the price-to-earnings ratio, the higher the company's growth has to be to justify the cost.
PEGY takes the comparison a step further than a simple P/E ratio. It integrates the firm's dividend yield as well. So now...you're not only measuring how much earnings you get from a company, but the amount of cash the firm pays out in a dividend as well.
The PEGY ratio takes into account a basic dichotomy. There are two fundamental ways an investor makes money on an equity investment: capital appreciation or dividend payments. Either you buy low and sell high, or you get cash payments from the company (the firm distributing a portion of its profits to shareholders in the form of dividends). Cutting edge industries (drug development, tech startups, etc.) tend to aim for capital appreciation. You'll buy the stock now at $5 a share and, in five years, sell it for $500. Mature industries rely more on dividends. You don't expect a big appreciation in the stock's price over time (a slow, Steady Eddie increase would be nice), but in exchange for a lower possible stock price appreciation, you get stability (a lower chance at a big drop) and a dividend payment.
The PEGY ratio tries to put these companies on the same footing, so its easier to compare them. Start with the firm's P/E ratio. (To calculate this, divide its share price by the earnings per share it posts.) Then divide the P/E ratio by the company's projected growth rate and its dividend yield. The result represents the PEGY for that equity.
Some companies might have high growth and low (if any) dividends. Others might have low growth and high dividend rates. Yet another class of companies might split the difference between the two. The PEGY gives you a basis of comparison.
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