Case: Companies in the US home electronics sector
Figure 1: Six companies in the US home electronics industry
The table above shows the market cap and PER of the six companies in the US home electronics sector as of August 27, 2020. Xiaomi has the highest PER while Panasonic has the lowest. Apple, which has a market cap of more than $2trillion, has 36, showing a high PER among the six companies. Companies having higher than the average PER of 26.67 are Apple, Xiaomi, and Casio. Those lower than the average are Sony, Panasonic, and Casio.
Definition of PEG
Fund managers and analysts compare PER and growth rate together to see whether stocks are undervalued or overvalued. If it has a low PER compared to a high growth rate, it will be undervalued. If it has a high PER compared to a low growth rate, it will be overvalued.
PEG refers to how many times a company has in PER compared to the growth rate. It is difficult to judge which stock is undervalued or overvalued when comparing only PER across companies. However, comparing PEG could yield meaningful outcomes. In particular, PEG can be more useful in high-growth sectors where the growth rate across firms varies.
PEG is the PER divided by the growth rate of EPS. Therefore, the lower the PEG, the more undervalued.
PEG = PER / gEPS
gEPS: Growth rate of EPS
The growth rate in the numerator should be from net income or EPS, not operating income or EBITDA. Since P/E refers to the transaction multiple of the stock price to EPS, it should be valued coherently using the growth rate of EPS. In addition, if the growth rate is from the current EPS, the denominator should be the current PER. If it is from the trailing EPS, then the trailing PER should be used. You can’t use the forward PER because it has the growth rate in itself. Also, you should use the growth rates of the same period for all comparable companies. When some companies use the 5-year growth rate of EPS and some use the 1-year growth rate, different standards are applied.
Figure 2: Investment Banking Five-Year Growth Forecast for Six Firms and PEG
As for the six companies, some investment banks predicted their growth rate over the next five years. In the above Excel, each PEG was obtained by dividing the trailing PER by the growth rate. The average PEG of the six companies is 2.34. The companies having higher than the average PEG are Panasonic, Kyocera and Apple. The companies lower than it are Sony, Xiaomi, and Casio. Xiaomi has the highest PER of 40, but it is a relatively undervalued firm compared to the growth rate with the PEG of 1.89. Casio has a high PER of 32, but its PEG is 1.48, which is the most undervalued among the six companies. Conversely, Panasonic’s PER is the lowest at about 14, but the PEG is the highest at 3.51, which is the most overvalued compared to the growth rate. Meanwhile, Apple’s PER is about 36 times high, but the PEG is close to the average of the six companies.
Evaluation using PEG
Like PER, PEG is useful when comparing companies in the same sector. Some industries may have high PEG and some may have low one because PEG is also formed with the risk, potential growth rate, dividend rate, or ROE. When comparing PEG across the companies from the diffrent industries, the following could be observed:
- PEG varies greatly with growth rate. Usually, PEG decreases as the growth rate increases. However, after a certain point, it reverses so as the growth rate increases, PEG also rises. Thus, firms with very high or very low growth rate may exhibit higher PEG than firms with moderate growth rate.
- Firms with high risk usually show a low PEG. Thus, they may appear to be undervalued than firms with low risk.
- Firms with low ROE or dividend payout ratio may appear to be undervalued compared to firms with high ROE or dividend payout due to low PEG.
In conclusion, when comparing PEG across companies with different profiles, some companies may appear to be undervalued due to low PEG. However, it could be a company with a higher risk or lower ROE.
- (Excel Financial Model) Valuation of Dyson’s stock, a private company, using PER
- (Blog) PER and Valuation of a Private Company – Case of Dyson
- (Blog) Judging the Level of Stock Price by using an Intrinsic PER