Pegging

Categories: Metrics

Pegging is not something from a prison movie, a Deadpool 2 joke, nor a global currency management strategy that grew out of Bretton Woods.

Instead, PEG actually stands for price-to-earnings-to-growth, and the term refers to when shareholders get paid back for taking risk in buying a high multiple (i.e. high price-to-earnings ratio) stock.

So...let's say you have a stock trading at 10 times earnings, where earnings should be flat the next decade. Well, you have 10 years to get all your money back, including dilution from stock options and other weird things that happen along the way. The PEG payback period is 10 years.

The reason that the PEG Payback Period even became a Thing is that, in bubbles, where companies are growing 100% a month for a while, investors pay 300x earnings or more, and that "insane" multiple makes old geezers scratch their heads and laugh about how stupid the investors are who are paying such a high multiple.

Well, Yahoo came public in the mid '90s at a valuation of about $260 million. It had $1 million in notional (i.e., kinda made up with a wink) earnings. So yes, it came public at 260x earnings. Insane, right? Well, in hindsight, just 3 years later it had earnings of about $260 million. So yes, it came public at 1 times 3 year forward earnings. Only one times earnings. How cheap is that? Well, you need to have a bit of vision, a bit of faith, hope, and of course prayer helps. But think about how all the old people who laughed at the Yahoo IPO as insanely expensive felt after the stock went up 300 times in value in 6 years? Yeah, take that, naysayers.

Anyway, the PEG Ratio series is all about rationalizing "insane" valuaitons with "insane growth," as some crazy, growthy things have happened in this internet era. Would anyone have guessed that the ant named Amazon in 1995 would end up destroying Walmart? Well, Jeff did. Not sure who else though.

Related or Semi-related Video

Finance: What is Price-to-earnings-to-gr...5 Views

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Finance Allah shmoop what is priced toe earnings to growth

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or a peg ratio You know what the P E

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ratio is right And if you don't I'll check out

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our fine opus on said Subject Here it's him up

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So price here's build a bore Stock trading at forty

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bucks a share It had net income or earnings last

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year of two bucks a share in trades at yes

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twenty times earnings So that's a P and in hee

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price and in earnings there it trades at twenty times

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earnings Um yeah So what does that mean Well if

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it held the earnings flat and basically all of its

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earnings was cash earnings Not like some fancy accounting trick

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Well if earnings were flat for twenty years well the

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company would have made back all of its valuation in

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cash profits and everyone would yawn right Twenty years at

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two bucks a year twenty times two is forty right

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Well that company would have paid up five percent cash

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return yield Right Two bucks in earnings over forty bucks

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a share to over forty in California and in Texas

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is five percent So is that a good return about

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return Was there a lot of risk in that number

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Growth shrinkage Wealth in a peg ratio Earnings growth is

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taken into consideration when evaluating the ratios of a stock

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So twenty times earnings is kind of a ho hum

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multiple But this company has no growth so that twenty

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times is probably a pretty high multiple as a multiple

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You know all things considered like twenty years a long

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time to get all your money back What if earnings

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were doubling each year for the next five years Like

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earnings went from two to four to eight to sixteen

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to thirty two bucks a share Well then twenty times

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earnings was ludicrously cheap Growth was one hundred percent versus

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that zero percent where twenty times earnings Look you know

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decent Well the basic idea and this one is coined

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by Peter Lynch the famed portfolio manager who brought Fidelity

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to fame Is that a peg ratio of one means

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that a stock is basically fairly priced that is P

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E ratios need contexts specifically the context of earnings growth

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The formula takes the P E ratio say it's a

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twenty and then puts it over the annual earnings per

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share growth number and note that it's per share not

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just overall company earnings Like if a company grew earnings

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by acquiring for stock a lot of competitors well it's

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share count would balloon While it's earnings grew fast as

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well but likely the dilution and suffered would mitigate most

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of the upside in earnings growth So on our twenty

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times earnings number a company with no growth gives us

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a peg ratio of twenty over zero which is an

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undefined number But peg ratio is all about how expensive

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the price to earnings ratio is relative to the growth

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of the company Wow we did not see that plot 00:02:45.65 --> [endTime] twist coming yellow

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