{"id":17854,"date":"2019-02-08T08:34:01","date_gmt":"2019-02-08T08:34:01","guid":{"rendered":"http:\/\/thepatientinvestor.com\/?p=17854"},"modified":"2019-05-23T02:02:25","modified_gmt":"2019-05-23T02:02:25","slug":"price-earnings-versus-growth","status":"publish","type":"post","link":"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/","title":{"rendered":"Price-Earnings versus Growth"},"content":{"rendered":"<p>A comment at lunch today about high price-earnings multiples got me started on one of my favorite topics: investment returns.<\/p>\n<p>Most of us use the basic price-earnings ratio (PE or P\/E) as a rough measure of how highly priced a stock is. The higher the P\/E, the higher the risk.<\/p>\n<p>But P\/E only focuses on current earnings and ignores future growth which can make a huge difference to the return on your investment.<\/p>\n<p>The PEG ratio, popularized by Peter Lynch in <em>One Up On Wall Street<\/em>, attempts to address this deficiency by dividing the price-earnings ratio by expected long-term growth rate of earnings.<\/p>\n<ul>\n<li>more than 1.0 is poor;<\/li>\n<li>less than 1.0 is good;<\/li>\n<li>less than 0.5 is excellent.<\/li>\n<\/ul>\n<p>Comparing P\/E to long-term growth is a step in the right direction but the PEG ratio has two notable deficiencies:<\/p>\n<ul>\n<li>It ignores dividends; and<\/li>\n<li>It assumes that the relationship between P\/E and growth is linear.<\/li>\n<\/ul>\n<h3>Dividends<\/h3>\n<p>It is fairly obvious that two stocks trading on the same P\/E, and with the same expected long-term growth rate, do not present the same value if one pays regular dividends and the other does not. PEG can be adjusted to compensate for this deficiency, by adding the dividend yield to the expected growth rate. If we assume Computershare (ASX:CPU), for example, has a long-term growth rate of 10%, this should be adjusted to 12% to include the expected 2% dividend yield.<\/p>\n<h3>P\/E versus Growth<\/h3>\n<p>The relationship is not linear. Take a look at the graph below which compares P\/E ratios on the vertical axis to Growth (including dividend yield) on the horizontal axis.<\/p>\n<p><img data-recalc-dims=\"1\" decoding=\"async\" class=\"aligncenter\" src=\"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png?w=525&#038;ssl=1\" alt=\"PE versus Growth\" \/><\/p>\n<p>The gray line plots stock prices at a PEG ratio of 1. A P\/E of 10 intersects with growth at 10%, a P\/E of 20 with growth at 20%, etc.<\/p>\n<p>The green line plots an internal rate of return at 12.5% p.a. on investment. Here is a brief explanation of my calculation:<\/p>\n<blockquote><p>I project earnings of $1 at varying growth rates for a period of 20 years. Then I discount this at 12.5% p.a. to arrive at a present value which equates to the P\/E ratio (PV\/$1 earnings in Year 1). I assume an exit value of zero for two reasons: (a) to simplify the model; and (b) to compensate for declining growth rates over time. I can give you ten different alternatives but this seems the most effective treatment (and I am trying to avoid this reading like a PhD thesis).<\/p><\/blockquote>\n<p>The relationship between P\/E and expected growth rate is clearly exponential. If we require an annual return on investment (ROI) of 12.5% :<\/p>\n<ul>\n<li>A growth rate of 15% would justify a P\/E of 22; while<\/li>\n<li>A growth rate of 30% would justify a P\/E of 97.<\/li>\n<\/ul>\n<p>What is clear is that price may be dictated more by high expected earnings growth than by current earnings.<\/p>\n<p>How do we estimate long-term earnings growth? With difficulty.<\/p>\n<p>But this is the most important factor in determining a stock&#8217;s value so we need to make our best effort. Factors to consider include:<\/p>\n<ul>\n<li>Past revenue growth (earnings growth without corresponding revenue growth is difficult to sustain);<\/li>\n<li>Cash flow to fund future growth<\/li>\n<li>Market position\n<ul>\n<li>Market growth or market saturation<\/li>\n<li>Market share<\/li>\n<li>Ability to withstand competition (rising profit margins are often a good pointer)<\/li>\n<\/ul>\n<\/li>\n<\/ul>\n<h3>Conclusion<\/h3>\n<p>The next time you look at a PE ratio, remember that earnings growth may be more important than current earnings.<\/p>\n","protected":false},"excerpt":{"rendered":"<p>A comment at lunch today about high price-earnings multiples got me started on one of my favorite topics: investment returns. Most of us use the basic price-earnings ratio (PE or P\/E) as a rough measure of how highly priced a stock is. The higher the P\/E, the higher the risk. But P\/E only focuses on &hellip; <\/p>\n<p class=\"link-more\"><a href=\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\" class=\"more-link\">Continue reading<span class=\"screen-reader-text\"> &#8220;Price-Earnings versus Growth&#8221;<\/span><\/a><\/p>\n","protected":false},"author":1,"featured_media":0,"comment_status":"closed","ping_status":"open","sticky":false,"template":"","format":"standard","meta":{"_mo_disable_npp":"","_jetpack_memberships_contains_paid_content":false,"footnotes":""},"categories":[48],"tags":[1052,1624,2625,3999,2750],"class_list":["post-17854","post","type-post","status-publish","format-standard","hentry","category-earnings-dividends","tag-dividend-yield","tag-growth","tag-pe","tag-peg-ratio","tag-price-earnings-ratio"],"yoast_head":"<!-- This site is optimized with the Yoast SEO plugin v27.2 - https:\/\/yoast.com\/product\/yoast-seo-wordpress\/ -->\n<title>Price-Earnings versus Growth - the patient investor<\/title>\n<meta name=\"robots\" content=\"noindex, follow\" \/>\n<meta property=\"og:locale\" content=\"en_US\" \/>\n<meta property=\"og:type\" content=\"article\" \/>\n<meta property=\"og:title\" content=\"Price-Earnings versus Growth - the patient investor\" \/>\n<meta property=\"og:description\" content=\"A comment at lunch today about high price-earnings multiples got me started on one of my favorite topics: investment returns. 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But P\/E only focuses on &hellip; Continue reading &quot;Price-Earnings versus Growth&quot;\" \/>\n<meta property=\"og:url\" content=\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\" \/>\n<meta property=\"og:site_name\" content=\"the patient investor\" \/>\n<meta property=\"article:publisher\" content=\"https:\/\/www.facebook.com\/profile.php?id=61572934660810\" \/>\n<meta property=\"article:author\" content=\"https:\/\/facebook.com\/people\/The-Patient-Investor\/61572934660810\/\" \/>\n<meta property=\"article:published_time\" content=\"2019-02-08T08:34:01+00:00\" \/>\n<meta property=\"article:modified_time\" content=\"2019-05-23T02:02:25+00:00\" \/>\n<meta property=\"og:image\" content=\"http:\/\/static.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png\" \/>\n<meta name=\"author\" content=\"Colin Twiggs\" \/>\n<meta name=\"twitter:card\" content=\"summary_large_image\" \/>\n<meta name=\"twitter:label1\" content=\"Written by\" \/>\n\t<meta name=\"twitter:data1\" content=\"Colin Twiggs\" \/>\n\t<meta name=\"twitter:label2\" content=\"Est. reading time\" \/>\n\t<meta name=\"twitter:data2\" content=\"3 minutes\" \/>\n<script type=\"application\/ld+json\" class=\"yoast-schema-graph\">{\"@context\":\"https:\/\/schema.org\",\"@graph\":[{\"@type\":\"Article\",\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#article\",\"isPartOf\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\"},\"author\":{\"name\":\"Colin Twiggs\",\"@id\":\"https:\/\/thepatientinvestor.com\/#\/schema\/person\/d42b18d516a80149d739845749ac6454\"},\"headline\":\"Price-Earnings versus Growth\",\"datePublished\":\"2019-02-08T08:34:01+00:00\",\"dateModified\":\"2019-05-23T02:02:25+00:00\",\"mainEntityOfPage\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\"},\"wordCount\":567,\"publisher\":{\"@id\":\"https:\/\/thepatientinvestor.com\/#organization\"},\"image\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#primaryimage\"},\"thumbnailUrl\":\"https:\/\/www.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png\",\"keywords\":[\"dividend yield\",\"growth\",\"PE\",\"PEG ratio\",\"price-earnings ratio\"],\"articleSection\":[\"Earnings &amp; Dividends\"],\"inLanguage\":\"en-US\"},{\"@type\":\"WebPage\",\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\",\"url\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\",\"name\":\"Price-Earnings versus Growth - the patient investor\",\"isPartOf\":{\"@id\":\"https:\/\/thepatientinvestor.com\/#website\"},\"primaryImageOfPage\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#primaryimage\"},\"image\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#primaryimage\"},\"thumbnailUrl\":\"https:\/\/www.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png\",\"datePublished\":\"2019-02-08T08:34:01+00:00\",\"dateModified\":\"2019-05-23T02:02:25+00:00\",\"breadcrumb\":{\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#breadcrumb\"},\"inLanguage\":\"en-US\",\"potentialAction\":[{\"@type\":\"ReadAction\",\"target\":[\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/\"]}]},{\"@type\":\"ImageObject\",\"inLanguage\":\"en-US\",\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#primaryimage\",\"url\":\"https:\/\/www.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png\",\"contentUrl\":\"https:\/\/www.incrediblecharts.com\/images\/2018\/2019-02-09-peng.png\"},{\"@type\":\"BreadcrumbList\",\"@id\":\"https:\/\/thepatientinvestor.com\/index.php\/2019\/02\/08\/price-earnings-versus-growth\/#breadcrumb\",\"itemListElement\":[{\"@type\":\"ListItem\",\"position\":1,\"name\":\"Home\",\"item\":\"https:\/\/thepatientinvestor.com\/\"},{\"@type\":\"ListItem\",\"position\":2,\"name\":\"Price-Earnings versus Growth\"}]},{\"@type\":\"WebSite\",\"@id\":\"https:\/\/thepatientinvestor.com\/#website\",\"url\":\"https:\/\/thepatientinvestor.com\/\",\"name\":\"The Patient Investor\",\"description\":\"Smart. 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He co-founded Incredible Charts and writes the popular Trading Diary and Patient Investor newsletters. Using a top-down approach, Colin identifies key macro trends in the global economy before evaluating selected opportunities using a combination of fundamental and technical analysis. Focusing on interest rates and financial market liquidity as primary drivers of the economic cycle, he warned of the 2008\/2009 and 2020 bear markets well ahead of actual events. He founded PVT Capital (AFSL No. 546090) in May 2023, which offers investment strategy and advice to wholesale clients.\",\"sameAs\":[\"https:\/\/facebook.com\/people\/The-Patient-Investor\/61572934660810\/\",\"https:\/\/www.instagram.com\/colin_thepatientinvestor\",\"https:\/\/au.linkedin.com\/in\/colintwiggs\"],\"url\":\"https:\/\/thepatientinvestor.com\/index.php\/author\/investor\/\"}]}<\/script>\n<!-- \/ Yoast SEO plugin. -->","yoast_head_json":{"title":"Price-Earnings versus Growth - the patient investor","robots":{"index":"noindex","follow":"follow"},"og_locale":"en_US","og_type":"article","og_title":"Price-Earnings versus Growth - the patient investor","og_description":"A comment at lunch today about high price-earnings multiples got me started on one of my favorite topics: investment returns. Most of us use the basic price-earnings ratio (PE or P\/E) as a rough measure of how highly priced a stock is. The higher the P\/E, the higher the risk. 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Sales and earnings multiples are stretched despite weak expected sales and earnings growth for the March quarter -- with 458 of 503 stocks in the index having reported. S&P 500 The index is\u2026","rel":"","context":"In &quot;GDP and Activity&quot;","block_context":{"text":"GDP and Activity","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/economy\/gdp-and-activity\/"},"img":{"alt_text":"S&P 500","src":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2024\/2024-05-14-spx.png?resize=350%2C200&ssl=1","width":350,"height":200,"srcset":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2024\/2024-05-14-spx.png?resize=350%2C200&ssl=1 1x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2024\/2024-05-14-spx.png?resize=525%2C300&ssl=1 1.5x"},"classes":[]},{"id":18217,"url":"https:\/\/thepatientinvestor.com\/index.php\/2019\/05\/17\/is-the-sp-500-way-over-priced\/","url_meta":{"origin":17854,"position":1},"title":"Is the S&#038;P 500 way over-priced?","author":"Colin Twiggs","date":"May 17, 2019","format":false,"excerpt":"Robert Shiller's CAPE (Price\/10-year simple MA of inflation-adjusted earnings) is at 30.31, the second-highest peak (behind the Dotcom bubble) in 120 years. PEmax (Price\/highest prior 12-month earnings) is far lower at 21.04. I prefer this as a more accurate measure of stock pricing than CAPE. But PEmax is still high\u2026","rel":"","context":"In &quot;Stock Markets&quot;","block_context":{"text":"Stock Markets","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/stock-markets\/"},"img":{"alt_text":"","src":"","width":0,"height":0},"classes":[]},{"id":18597,"url":"https:\/\/thepatientinvestor.com\/index.php\/2019\/08\/01\/apple-inc-aapl-buybacks-dont-help\/","url_meta":{"origin":17854,"position":2},"title":"Apple Inc. (AAPL) &#8211; window dressing with buybacks","author":"Colin Twiggs","date":"August 1, 2019","format":false,"excerpt":"Apple (AAPL) is a notable omission in my international model portfolio. Here is one of the reasons. Michael Santoli at CNBC reports that Apple's sales and earnings over the past 4 years are essentially flat. The only metric that has improved is earnings per share (EPS) because of stock buybacks.\u2026","rel":"","context":"In &quot;International Growth&quot;","block_context":{"text":"International Growth","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/investment-allocation\/international-growth\/"},"img":{"alt_text":"","src":"","width":0,"height":0},"classes":[]},{"id":9043,"url":"https:\/\/thepatientinvestor.com\/index.php\/2014\/01\/26\/beware-of-the-cape\/","url_meta":{"origin":17854,"position":3},"title":"Beware of the CAPE","author":"ColinTwiggs","date":"January 26, 2014","format":false,"excerpt":"I have just read John Mauldin's warning that the market is overvalued: Not only does today's CAPE of 25.4x suggest a seriously overvalued market, but the rapid multiple expansion of the last few years coupled with sluggish earnings growth suggests that this market is also seriously overbought, as I pointed\u2026","rel":"","context":"In &quot;Stock Markets&quot;","block_context":{"text":"Stock Markets","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/stock-markets\/"},"img":{"alt_text":"CAPE","src":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=350%2C200&ssl=1","width":350,"height":200,"srcset":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=350%2C200&ssl=1 1x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=525%2C300&ssl=1 1.5x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=700%2C400&ssl=1 2x"},"classes":[]},{"id":13708,"url":"https:\/\/thepatientinvestor.com\/index.php\/2014\/01\/26\/beware-of-the-cape-2\/","url_meta":{"origin":17854,"position":4},"title":"Beware of the CAPE","author":"ColinTwiggs","date":"January 26, 2014","format":false,"excerpt":"I have just read John Mauldin's warning that the market is overvalued: Not only does today's CAPE of 25.4x suggest a seriously overvalued market, but the rapid multiple expansion of the last few years coupled with sluggish earnings growth suggests that this market is also seriously overbought, as I pointed\u2026","rel":"","context":"In &quot;Market Insights&quot;","block_context":{"text":"Market Insights","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/market-insights\/"},"img":{"alt_text":"CAPE","src":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=350%2C200&ssl=1","width":350,"height":200,"srcset":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=350%2C200&ssl=1 1x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=525%2C300&ssl=1 1.5x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2014\/mauldin-cape.png?resize=700%2C400&ssl=1 2x"},"classes":[]},{"id":43986,"url":"https:\/\/thepatientinvestor.com\/index.php\/2023\/09\/08\/overpriced-sp-500-ignores-declining-growth\/","url_meta":{"origin":17854,"position":5},"title":"Overpriced S&#038;P 500 ignores declining growth","author":"Colin Twiggs","date":"September 8, 2023","format":false,"excerpt":"The S&P 500 price-to-sales ratio jumped to 2.44 in June -- way above its long-term average of 1.68. Price-earnings ratio (PE) calculated using highest trailing earnings, surged to 22.5 in June -- well above the peaks from earlier crises like October 1929 (Black Friday) and October 1987 (Black Monday). Robert\u2026","rel":"","context":"In &quot;Banks &amp; Interest Rates&quot;","block_context":{"text":"Banks &amp; Interest Rates","link":"https:\/\/thepatientinvestor.com\/index.php\/category\/economy\/the-fed-banks-interest-rates\/"},"img":{"alt_text":"S&P 500 Price-to-Sales","src":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2023\/2023-09-07-spx--sales.png?resize=350%2C200&ssl=1","width":350,"height":200,"srcset":"https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2023\/2023-09-07-spx--sales.png?resize=350%2C200&ssl=1 1x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2023\/2023-09-07-spx--sales.png?resize=525%2C300&ssl=1 1.5x, https:\/\/i0.wp.com\/www.incrediblecharts.com\/images\/2023\/2023-09-07-spx--sales.png?resize=700%2C400&ssl=1 2x"},"classes":[]}],"_links":{"self":[{"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/posts\/17854","targetHints":{"allow":["GET"]}}],"collection":[{"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/posts"}],"about":[{"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/types\/post"}],"author":[{"embeddable":true,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/users\/1"}],"replies":[{"embeddable":true,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/comments?post=17854"}],"version-history":[{"count":6,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/posts\/17854\/revisions"}],"predecessor-version":[{"id":18261,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/posts\/17854\/revisions\/18261"}],"wp:attachment":[{"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/media?parent=17854"}],"wp:term":[{"taxonomy":"category","embeddable":true,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/categories?post=17854"},{"taxonomy":"post_tag","embeddable":true,"href":"https:\/\/thepatientinvestor.com\/index.php\/wp-json\/wp\/v2\/tags?post=17854"}],"curies":[{"name":"wp","href":"https:\/\/api.w.org\/{rel}","templated":true}]}}