LOS c: Illustrate why the PEG valuation technique must be used with care.

Q1. 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)   No, because the PEG ratio generates highly questionable results for low-growth companies.

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

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

Q2. 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 dividend discount growth prospects." Is Long correct?

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

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

C)   No, because the PEG ratio generates meaningless results for low-growth companies.

Q3. 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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Q1. 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)   No, because the PEG ratio generates highly questionable results for low-growth companies.

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

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

Correct answer is A)

The PEG ratio measures the tradeoff between P/E and expected dividend 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 dividend growth.

Q2. 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 dividend discount growth prospects." Is Long correct?

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

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

C)   No, because the PEG ratio generates meaningless results for low-growth companies.

Correct answer is C)

The PEG ratio measures the tradeoff between P/E and expected dividend growth (g). The formula for the PEG ratio is: PEG = (P/E) / g. As such, firms with negative expected dividend growth will have a negative PEG ratio, which is meaningless.

Q3. 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.

Correct answer is B)

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