Summary
The favorite investment strategies used by both individual investors and professional money managers include those that are based on the PE and PEG ratios. While much popular as well as academic attention has been bestowed upon the former, the sole previous research documents the extraordinary performance of a PEG-based investment strategy for growth stocks during the 1980s. Here we examine the robustness of this anomalous finding to an expanded sample during a subsequent period. Our findings suggest that PEG investing remains a profitable investment strategy, and that it extends its reach beyond the domain of growth stocks. Additionally, we document a risk profile for PEG-based strategies that is likely to be counterintuitive for most value investors.
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Extract
Peg Investing Strategy: A Revisit
Introduction
The traditional metric for measuring the richness of equity valuation since Graham and Dodd has been the price-to-earnings ratio (PE).1 By definition, stocks with low PE ratios have earnings per share (EPS) trading at a discount compared with competing equities in the financial market. Discounted-cash-flow models suggest that firms with higher growth prospects and lower required rates of return should have their equity trade at larger multiples of earnings relative to equities with contrary characteristics. Thus, a comparison of PE ratios with various benchmarks has become a favorite tool for investors who desire a value-style of investing. In an attempt to modify the PE to account for the first of these factors, investors have standardized the PE ratio by the firm's growth rate, giving rise to a compound metric known as the PEG ratio. This ratio is now commonly reported alongside the PE and other relevant firm characteristics on many web-based financial news services. The PEG ratio is considered the premier metric for the investment style popularly known as growth at a reasonable price (GARP).Growth-based valuation has a distinguished histoiy in the academic literature. Clendenin and van Cleave (1954) open their article:For almost a generation the identification and appraisal of '...See the full content of this document
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