Mike,
There are lots of definitional problems with the PEG ratio. The definition that makes most sense to me is to compare the forward P/E with projected forward growth. Earnings estimates of FY 2000 are $1.69, which yields a forward PEG of 1.74. This compares to a forward PEG of the S&P500 of 2.04.
Similarly, there are interpretational problems. I don't think that using the heuristic of a PEG < 1.00 is a buy signal because it is insensitive to interest rate changes. Lower interest rates supports higher stock prices. Hence, the PEG ratio would be shifted higher. I get around this by dividing the PEG of the stock by the PEG of the market to arrive at a normalized PEG. In this case it would be 1.74/2.04 = 0.85.
But even with this adjustment we have a problem, because this does not take into account the volatility (riskiness) of the position. If we use beta as a surrogate (flawed as it is) for risk, we should multiply the respective PEGs by their betas. Since the beta of the S&P is 1.00 (by definition), we should multiply the PEG of CTXS by 1.29 (the beta of CTXS according to Yahoo!), to give a normalized PEG of 1.10. This would indicate that CTXS is about 10% overvalued compared to the S&P500.
Finally, we have the question of the relevance of PEG ratios to any theoretical underpinning of the stock price. It seems to me that using earnings as a basis for stock prices is playing with fire. Earnings are accounting fictions designed to measure economic profit. They are dependant on estimates of depreciation and the like, and they are insensitive to the timing of cash flows. Furthermore, they treat acquisition charges inconsistently, depending on the accounting method (purchase or pooling). And to top it off, analysts tend to ignore the costs of acquisitions whish is a grave mistake IMO because these expenditures are made to drive future earnings.
So I suggest a much better approach is to use free cash flow (which is operating cash flow minus cash expenditures for capital expenses and acquisitions) as a basis for valuation.
TTFN,
CTC |
