Since NOK profit growth is not likely to exceed 50% going forward, and QCOM not likely to exceed 30% over next year, these would imply PEG ratios still greater than 1. It is only because of the extreme tech bubble we live in that PEs of 30 or 50 seem cheap.
First of all, even those who adhere to the PEG make it clear that it's not to be based on the growth a company's set to see in the following year, but the growth it's going to have over the following 3-5 years (really changes the Qualcomm estimates, doesn't it :-)?) With that said, let's go after the absurdity of the PEG instead. It's quite simple, actually, and I was hoping that by now, after all the years of growth that companies such as Cisco, Sun, Intel, etc. have had, the PEG would've been put to rest. Anyway, here we go:
Let's suppose we're looking at two companies: company A, with a P/E of 10 and set to grow at an average of 15% a year for the next four years, and company B, an optical networking company, with a P/E of 300 and set to grow at 85% annually for those four years. The former's cheap while the latter's ridiculously overvalued, right? Well, being value-oriented investors, we have to look long-term and extrapolate. Let's assume that at the end of those At the end of those four years, the P/E of company A has risen to 15, while the P/E of company B has collapsed to 80.
If this were to happen, over those four years, shares of company A would have appreciated by 162%. Not bad by any measure. However, shares of company B, a classic manifestation of "the extreme tech bubble we live in," would've increased by 227%, in spite of the huge multiple contraction. Kind of puts the PEG into perspective, doesn't it?
Am I saying that valuation shouldn't be taken into account for high-growth companies? Not at all. Using discounted cash flows for long time frames, factoring in different amounts of risk based on the dynamics surrounding the markets a company's involved in (obviously an optical networking firm would require a large amount of risk to be factored into any estimates done on it), is generally a good idea. And am I saying that this bull market hasn't created its share of overvalued companies? Not at all. I sincerely think that a number of profitless tech companies are grossly overvalued (i.e. Amazon, Exodus), as are a number of tech companies whose core businesses involve selling inferior products in highly competitive environments (F5, Inktomi).
However, I can't see how a fast-growing company that has a competent management team and significant competitive advantages over its rivals can be considered overvalued simply because it has an above-averge PEG.
Eric |
