21 November 2023
Investor Education
PEG: A magician's wand!
Have you ever pondered on the common traits shared by wizards who achieved substantial wealth through long-term stock investments? Almost all of them, including iconic figures like Warren Buffet, Peter Lynch, and Charlie Munger, relied heavily on fundamental analysis, with a consistent focus on the stock's intrinsic value.
However, determining a stock's true worth isn't straightforward; if it were, the game would be too easy! The process involves numerous assumptions and subjective evaluations.
Enter the PEG ratio, a concept often referenced by Peter Lynch. Today, let's delve into the captivating realm of the Price/Earnings to Growth (PEG) ratio and understand why it's considered a magical tool in the world of investing.
The PEG ratio is a dynamic metric that harmonizes current earnings with future growth potential. It transcends the present moment, acting as a forward-thinking compass that guides us through the intricate landscape of stock valuation.
Here's the enchanting revelation: a PEG ratio less than one often signifies that a stock may be undervalued relative to its anticipated earnings growth. It's akin to possessing a crystal ball that allows us to peer into a stock's potential future performance.
The PEG formula follows: PEG = PE ratio (based on trailing twelve months) divided by expected annual EPS growth for at least two years.
Applying the PEG ratio is an art. A PEG that's too low can be a risky bet, suggesting there might be information the market is privy to that you're missing. The higher the expected growth rates, the more lenient one should be with the PEG. In the Indian context, a PEG beyond 2 indicates an overvalued stock.
Imagine this ratio as the magician's wand in our financial toolkit, unveiling insights beyond the surface-level price-to-earnings (P/E) ratio. It offers a nuanced understanding of a company's valuation, considering its current profitability and expectations for future growth.
Let's infuse our investment journey with a touch of magic!
Happy investing!
Dr. Anil Kumar Asnani
SEBI Reg. Research Analyst
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