PEG does not assume a non-linear relationship between PE and growth? Why is that?
Beause it assumes a linear relationship! (it’s a double-negation trick). In other words it applies to one stage growth models only. In multistage GGM the growth is non-linear.
Oh so PEG is single stage, and linear. Thanks!
With all due respect, that’s not what it means.
What it means is that it assumes that if you, for example, double the growth rate, the P/E ratio should double. It assumes, for example, that these two situations should be considered equivalent:
- Company A: P/E = 10, g = 1%
- Company B: P/E = 50, g = 5%
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However, the company B is riskier. That’s one of the flaws of valuation using PEG, it does not consider risk.
True.
However, the point I was making is that Company B’s P/E ratio is way too high. The difference between 1% growth and 5% growth might justify a difference in P/E ratios of, say, 10 and 20, but not 10 and 50.
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Totally agree. The expectations of future earnings growth are collapsed in the stock price today.
I dont think PEG is flawed. I think PEG is about as useful as PE. Its a realative measure and one input to be concidered, if you base your portfolio off of it you may be in some trouble.
If you based all investment decisions off of PE you would be in the same situation.
PEG seems to basically be an attempt to standardize a PE ratio to account for differences in growth rates, and it seems to do it decently enough
Why do we keep the denominator at 1 and not .01 when dividing to calculate the PEG ratio?
Nobody knows.
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