Overview
This lecture explains key stock valuation ratios—PE, PEG, and PEGY—emphasizing Peter Lynch's methods to identify undervalued stocks by accounting for growth and dividends.
PE Ratio: The Basics
- The Price-to-Earnings (PE) ratio is calculated by dividing stock price by earnings per share (EPS).
- A lower PE ratio means you pay less for each dollar of earnings; it suggests a cheaper stock.
- PE does not account for company growth rates, so it can be misleading when comparing different stocks.
PEG Ratio: Adjusting for Growth
- The Price/Earnings-to-Growth (PEG) ratio is PE divided by the company's earnings growth rate.
- PEG improves on PE by showing if higher price is justified by faster growth.
- A PEG below 1 suggests the stock might be undervalued; above 1 may indicate overvaluation.
- Peter Lynch popularized using the PEG ratio for smarter stock valuation.
PEGY Ratio: Including Dividends
- The PEGY ratio is PE divided by the sum of earnings growth rate plus dividend yield.
- PEGY rewards stocks that not only grow but also pay dividends to shareholders.
- A PEGY ratio below 1 suggests undervaluation, especially if dividend yield is high.
- PEGY gives a more complete valuation picture than PE or PEG alone.
Applying the Framework
- Calculate PE to get baseline valuation.
- Use PEG to evaluate if price is justified by growth.
- Use PEGY to factor in both growth and dividends.
- Always consider other factors like financial health and competitive position; ratios are a starting point.
Key Terms & Definitions
- Price-to-Earnings (PE) Ratio — Stock price divided by earnings per share, measuring how much investors pay per dollar earned.
- PEG Ratio — PE ratio divided by earnings growth rate; measures valuation adjusted for growth.
- PEGY Ratio — PE ratio divided by the sum of earnings growth rate plus dividend yield; factors in both growth and dividends.
- Dividend Yield — The annual dividend per share divided by stock price, expressed as a percentage.
Action Items / Next Steps
- Use a PEGY calculator to evaluate potential stock investments.
- Review company financial health and business prospects beyond these ratios.
- Optional: Watch the recommended video on Seth Klarman’s money lessons for further learning.