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Strategies & Market Trends : Gorilla and King Portfolio Candidates
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To: Mike Buckley who wrote (42366)5/3/2001 11:55:12 AM
From: Pirah Naman  Read Replies (1) of 54805
 
Mike:

Two points, the first a simple clarification of something you hinted at. All of this "five quarters out" or "seven quarters out" really points out the need for people to not take offered forward looking PEGs at face value, but to determine their own forward looking PEGs using the next four fiscal quarters. Usually quarter by quarter projections are available; if not, one can interpolate from the current and next fiscal years.

The big reason PEGs tend to undervalue an emerging or strong Gorilla is because the earnings picture tends to improve long after the period of time the PEG addresses.

I disagree. The big reason that PEGs tend to undervalue such companies is because of a problem inherent to PEGs. PEGs assume a linearity that does not exist. An asset which puts out a constant, not growing, stream of free cash flows is not equal to zero. The faster an asset increases its asset flows, the more it deviates to a value well above where its PEG suggests it.

Even B. Graham recognized this - his formula for the value of a company based on its earnings started with "8.5+..." - though even that is only good, as Graham acknowledges, for growth rates which are modest.

There is no need for us to use the linear relationship, or even to come up with discreet rules of thumb. If one understands the underlying principles one can come up with a chart which gives the appropriate PE ratio for any given growth rate. Which will work much better for emerging or strong gorillas.

Of course, we still have the problem of guessing at future growth rates.

- Pirah
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