Reading 44: Market-Based Valuation: Price and Enterprise Val 2011, interpret, valuation, relative, center

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Session 12: Equity Investments: Valuation Models
Reading 44: Market-Based Valuation: Price and Enterprise Value Multiples

LOS l: Calculate and interpret the P/E-to-growth ratio (PEG), and explain its use in relative valuation.

 

 

Consider the statement: "Unlike many valuation metrics that incorporate dividend discounting, the PEG ratio may be used to value firms with zero expected dividend growth prospects." Is this statement correct?

A) Yes, because the expected dividend growth rate is cancelled out in the computation of the PEG ratio.

B) No, because the PEG ratio is undefined for zero-growth companies.

C) Yes, because the computation of the PEG ratio does not use the rate of expected dividend growth.

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The PEG ratio measures the tradeoff between P/E and expected earnings growth (g). The formula for the PEG ratio is: PEG = (P/E) / g. Firms with zero expected earnings growth will have an infinite (or undefined) PEG ratio due to division by zero.

[此贴子已经被作者于2011-3-21 11:34:54编辑过]

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Two security analysts, Ramon Long and Sri Beujeau, disagree about certain aspects of the PEG ratio. Long argues that: "unlike typical valuation metrics that incorporate dividend discounting, the PEG ratio is unique because it generates meaningful results for firms with negative expected earnings-growth." Is Long correct?

A) No, because the PEG ratio generates meaningless results for negative earnings-growth companies.

B) Yes, because the expected earnings-growth rate is cancelled out in the computation of the PEG ratio.

C) Yes, because the computation of the PEG ratio does not use the rate of expected earnings growth.

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The PEG ratio is: PEG = (P/E) / earnings growth. As such, firms with negative expected earnings growth will have a negative PEG ratio, which is meaningless.

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The definition of a PEG ratio is price to earnings (P/E):

A) divided by the average growth rate of the peer group.

B) divided by average historical earnings growth rate.

C) divided by the expected earnings growth rate.

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The PEG ratio is P/E divided by the expected earnings growth rate.

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Which of the following statements regarding the P/E to growth (PEG) valuation approach is least accurate? The P/E to growth (PEG) valuation approach assumes that:

A) there are no risk differences among stocks.

B) there is a linear relationship between price to earnings (P/E) and growth.

C) stocks with higher PEGs are more attractive than stocks with lower PEGs.

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The PEG valuation approach implicitly assumes there is a linear relationship between price to earnings (P/E) and growth, even though there is not a "real world" linear relationship. The analyst must be cautious when using the PEG ratio for valuation or comparison purposes especially if the growth rate is very small or very large. If earnings or the growth rate is negative the PEG ratio is meaningless. The PEG ratio does not adjust for varying levels of risk among stocks and views stocks with lower PEG ratios to be more attractive than stocks with higher PEG ratios.

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The relative valuation model known as the PEG ratio is equal to:

A) earnings per share growth rate / price-to-earnings.

B) price-to-earnings (P/E) / earnings per share (EPS) growth rate.

C) P/E × earnings.

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The PEG ratio is equal to the price-to-earnings ratio divided by the EPS growth rate.

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Good Sports, Inc., (GSI) has a leading price-to-earnings (P/E) ratio of 12.75 and a 5-year consensus growth rate forecast of 8.5%. What is the firm’s P/E to growth (PEG) ratio?

A) 150.00.

B) 1.50.

C) 0.67.

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The firm’s PEG is 12.75 / 8.50 = 1.50.

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At a regional security analysts conference, Sandeep Singh made the following comment: "A PEG ratio is a very useful valuation metric because it generates meaningful results for all equities, regardless of the rate of dividend growth." Is Singh correct?

A) Yes, because the expected dividend growth rate is cancelled out in the computation of the PEG ratio.

B) No, because the PEG ratio generates highly questionable results for low-growth companies.

C) Yes, because the computation of the PEG ratio does include the rate of expected dividend growth.

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The PEG ratio measures the tradeoff between P/E and expected earnings growth (g). The formula for the PEG ratio is: PEG = (P/E) / g. PEG ratios generate questionable results for low-growth companies. Also, the PEG ratio is undefined for companies with zero expected growth (division by zero) or meaningless for companies with negative expected earnings growth.

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For which of the following firms is the Price/Earnings to Growth (PEG) ratio most appropriate for identifying undervalued or overvalued equities?

Firm A: Expected dividend growth = 6%; Cost of equity = 12%; price-to-earnings (P/E) = 12.
Firm B: Expected dividend growth = ?6%; Cost of equity = 12%; price-to-earnings (P/E) = 12.
Firm C: Expected dividend growth = 1%; Cost of equity = 12%; price-to-earnings (P/E) = 12.

A) Firm C.

B) Firm A.

C) Firm B.

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The formula for the PEG ratio is: PEG = (P/E) / g. It measures the tradeoff between P/E and expected dividend growth (g). For traditional growth firms, PEG ratios fall between 1 and 2. The general rule is that PEG ratios above 2 are indicative of overvalued firms (expensive), and PEG ratios below 1 are indicative of firms that are undervalued (cheap).

Firm A:	PEG = 2, indicating a stock that is appropriately priced.
Firm B:	The PEG ratio of firms with negative expected dividend growth is negative, which is meaningless. For Firm B, PEG = -2.
Firm C:	Firms with very low expected dividend growth are likely to have PEG ratios that unrealistically indicate overvalued stocks. For Firm C, PEG = 12.