Price-To-Innovation-Adjusted Earnings

Finance Allah shmoop what is priced toe earnings to growth

or a peg ratio You know what the P E

ratio is right And if you don't I'll check out

our fine opus on said Subject Here it's him up

So price here's build a bore Stock trading at forty

bucks a share It had net income or earnings last

year of two bucks a share in trades at yes

twenty times earnings So that's a P and in hee

price and in earnings there it trades at twenty times

earnings Um yeah So what does that mean Well if

it held the earnings flat and basically all of its

earnings was cash earnings Not like some fancy accounting trick

Well if earnings were flat for twenty years well the

company would have made back all of its valuation in

cash profits and everyone would yawn right Twenty years at

two bucks a year twenty times two is forty right

Well that company would have paid up five percent cash

return yield Right Two bucks in earnings over forty bucks

a share to over forty in California and in Texas

is five percent So is that a good return about

return Was there a lot of risk in that number

Growth shrinkage Wealth in a peg ratio Earnings growth is

taken into consideration when evaluating the ratios of a stock

So twenty times earnings is kind of a ho hum

multiple But this company has no growth so that twenty

times is probably a pretty high multiple as a multiple

You know all things considered like twenty years a long

time to get all your money back What if earnings

were doubling each year for the next five years Like

earnings went from two to four to eight to sixteen

to thirty two bucks a share Well then twenty times

earnings was ludicrously cheap Growth was one hundred percent versus

that zero percent where twenty times earnings Look you know

decent Well the basic idea and this one is coined

by Peter Lynch the famed portfolio manager who brought Fidelity

to fame Is that a peg ratio of one means

that a stock is basically fairly priced that is P

E ratios need contexts specifically the context of earnings growth

The formula takes the P E ratio say it's a

twenty and then puts it over the annual earnings per

share growth number and note that it's per share not

just overall company earnings Like if a company grew earnings

by acquiring for stock a lot of competitors well it's

share count would balloon While it's earnings grew fast as

well but likely the dilution and suffered would mitigate most

of the upside in earnings growth So on our twenty

times earnings number a company with no growth gives us

a peg ratio of twenty over zero which is an

undefined number But peg ratio is all about how expensive

the price to earnings ratio is relative to the growth

of the company Wow we did not see that plot 00:02:45.65 --> [endTime] twist coming yellow