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| source: http://www.valuewalk.com/ |
I bet by now you are in the level where we can say you are already a serious stock trader or investor. I know you you have been going from side to side, that is employing TECHnical and FUNdamental analysis to guide you in your stock bids or ask.
Another fundamental ratio which we can use to make sound judgement is the PEG Ratio.
PEG Ratio is defined by Investopedia.com as:
As the definition says it is a valuation ratio taking into consideration the expected earnings growth. It is an estimate of the company's value(as reflected by the PE ratio) over an expected growth rate.
To learn more you can watch Investopedia.com's video presentation about this ratio below:
PEG Ratio just like PE Ratio can be use to check which stock is undervalued and thus making a good buying decisions.
Now how can you use PEG Ratio in your trading or investing? Here is the catch with this ratio: one has to understand risk in order to use this valuation ratio properly.
What risk again?
Yes, since PEG Ratio is a measure of the future earnings which is still uncertain you have to take into consideration the risk associated with the stock. Also comparing one stock from the other might lead you to wrong decisions. Every company may have different nature of risk like a service company will have different risk as compared with a holding company. Thus PEG Ratio is best use when comparing companies with the same nature and level of risk.
I have checked PEG Ratio of ALI & SMPH for 2011 in COLFinancial website and here is what I got:
Lets use the above data to analyze these two stocks using PEG ratio.(Remember this is a 2011 data for example purpose only)
Price Comparison
Just looking at the price I guess you would have bought SMPH if you wanted to add a property stock in your portfolio. The lower price would mean you would be able to buy more stock with your limited funds.
PE Ratio comparison
If you would base your buy decision you would probably buy SMPH right away because as compared to ALI it is way more cheaper to buy SMPH with a good return. Again PE is based on the current earnings but in reality you are just in the position to buy, you have to also consider the probability of you earning after buying the stock unless you intend to go short which will surely give you a good return since the stock is cheaper.
PEG Ratio comparison
Looking at the PEG ratio it would tell you that comparing the future earnings ALI would be the better stock to buy. Again remember the risk that comes with this ratio. It is more of an estimate which may change upon unexpected events who knows SMPH would embark in new and better projects that would solidify its capability to generate better earnings next year thus changing the PEG ratio.
So there you go. PEG ratio will be best use if you are deciding between two stocks of the same industry and for sure for a time frame longer than months.
Now how can you use PEG Ratio in your trading or investing? Here is the catch with this ratio: one has to understand risk in order to use this valuation ratio properly.
What risk again?
Yes, since PEG Ratio is a measure of the future earnings which is still uncertain you have to take into consideration the risk associated with the stock. Also comparing one stock from the other might lead you to wrong decisions. Every company may have different nature of risk like a service company will have different risk as compared with a holding company. Thus PEG Ratio is best use when comparing companies with the same nature and level of risk.
I have checked PEG Ratio of ALI & SMPH for 2011 in COLFinancial website and here is what I got:
| STOCK | 2011 Price | PE 2011 | PEG 2011 |
| ALI | 15.16 | 27.93 | 0.90 |
| SMPH | 10.64 | 16.33 | 1.07 |
Lets use the above data to analyze these two stocks using PEG ratio.(Remember this is a 2011 data for example purpose only)
Price Comparison
Just looking at the price I guess you would have bought SMPH if you wanted to add a property stock in your portfolio. The lower price would mean you would be able to buy more stock with your limited funds.
PE Ratio comparison
If you would base your buy decision you would probably buy SMPH right away because as compared to ALI it is way more cheaper to buy SMPH with a good return. Again PE is based on the current earnings but in reality you are just in the position to buy, you have to also consider the probability of you earning after buying the stock unless you intend to go short which will surely give you a good return since the stock is cheaper.
PEG Ratio comparison
Looking at the PEG ratio it would tell you that comparing the future earnings ALI would be the better stock to buy. Again remember the risk that comes with this ratio. It is more of an estimate which may change upon unexpected events who knows SMPH would embark in new and better projects that would solidify its capability to generate better earnings next year thus changing the PEG ratio.
So there you go. PEG ratio will be best use if you are deciding between two stocks of the same industry and for sure for a time frame longer than months.
3 comments:
The thing you can say is that the market discounts a higher future growth in ALI than in SMPH.
Everybody knows that ALI is know because of their quality and they sell very quickly, that is why people are ready to pay more for ALI, it will be more resilient to future events.
The only way to make money is to know something that the market doesn't know and that gives you a hedge.
It's important to understand why the market is pricing both companies like that and why you think that the market is wrong and you are right.
The Ratios will only tell you something about the past, the price will tell you the future expectations of the market participants.
My question is not, is it true that ALI is overvalued compared to SMPH because of the PEG ratio? my question is, is the market right about the future expectations of both companies? It's obvious that the market has bigger expectations for ALI.
Very true sir Dalamar. Having that edge, that is knowing things before others do, puts you ahead of the pack. That is why one should always be on the look out. Not that ratios are useless but let us use them to guide us to uncover something everybody else is looking for in the hay stack.
Thanks sir Dalamar for sharing us great thoughts on stock investing.
Very informative article! An equation to help you make good decisions; great decisions will lead to a great bargain.
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