Price Earning Growth (PEG) Ratio Is The Ratio Of A Company's PE With Its Growth Rate. A Lot Of Analysts Have Concurred That A Stock Is Fairly Valued When Its PEG Ratio Equal One. This Means That If A Stock Has A PE Of 10 With A Growth Rate Of 10, Then The Stock Is Trading At Fair Value.How Many Of You Have Seen This Kind Of Statement? I Have Seen It Plenty Of Times And I Think It Is Silly. This Is A Relatively Simple Reasoning. Let's Think Of It For A Second. If A Stock Will Grow Its Earning For 8, Then To Reach Fair Value, The Stock Has To Trade At A PE Of 8. How About A Stock With Growth Rate Of 5? Its Fair Value Is A PE Of 5. How About A Company With 0 Growth? Oh, Right. According To This Theory, The Company Should Have A PE Of 0, Or Worthless. Does This Make Sense? Heck, No. But There Are A Lot Of Articles Regarding This PEG Theory. Here Are Several Sources Of Commonly Misunderstood PEG Ratio:http:www.moneychimp.comglossarypegratio.htm Http:www.fool.comSchoolTheFoolRatio.htm Http:www.investopedia.comarticlesanalyst043002.aspFor A 0 Growth Company, The Fair PE Ratio For The Company Is Not 0. Rather, It Is A Few Percentage Above Risk-free Interest Rate Or A Ten Year Treasury Bond. If A Ten Year Bond Is Yielding 4.6, Then The Fair Value Of A Common Stock Is At 7.6 Yield. Inverting This Yield, We Get A PE Ratio Of 13.2.Anything Else Is Wrong With Using PEG Ratio To Determine The Fair Value Of A Common Stock? PEG Assumes Infinite Growth Rate In Earning Per Share. No Company Can Grow At The Same Rate Forever. If We Assume Company A Will Grow At 10 Rate For The Next Five Years And Then Growth Slows To 2 Indefinitely, What Is The Fair Value Of The Common Stock Using PEG Ratio? The Answer Is It Can't Do That. PEG Ratio Is Way Too Simple To Single-handedly Assign A Fair Value For A Common Stock. It Is Misleading And Simply Wrong To Use PEG Ratio For Our Fair Value Calculation.Common Sense Dictates That A Stock With Higher Growth Rate Should Be Valued At A Higher PE Ratio. There Is Nothing Wrong With That. But Using A Simple PEG Ratio Of One As A Fair Value Of A Common Stock Is Simply Wrong. I Don't Have An Accurate Way To Calculate This But An Estimation Can Be Read On Other Articles Entitled Calculating Fair Value With Growth And Fair Value With Negative Growth.
