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To: jttmab who wrote (123935)	5/12/1999 12:06:00 AM
From: Chuzzlewit	Read Replies (2) \| Respond to of 176387

Jim, the approach I used is fraught with theoretical and practical pitfalls, and is intended to provide us with relative valuations. But the problem, then, is relative to what? The first problem I came across is that the base index contains companies that are not making any profit. That leads to a gross distortion of PEG values. For example, suppose we have company A trading at $100 with earnings of $4, and company B trading at $30 with earnings of $<1>. If each has an equal capitalized value, then the value of the index is $130 with earnings of $3. So you see how the inclusion of such companies in the index creates a problem. It was probably this effect that made you want to want to short the whole index! In any event, I arbitrarily shave off about 20% of the YPEG ratio to account for this. The second problem is whether we need to adjust for risk, and if so, what is a proper metric for risk adjustment. I think risk adjustment is necessary, because I think stocks need to trade at some risk-adjusted discount to the YPEG. Icannot prove this, but I suspect that the risk is much greater for the stock of companies with expected growth rates of 5-10% than for companies with expected growth rates of 40%. That means that all other things being equal, a stock with expected growth of 40% should not be trading at four times the multiple of a stock with expected growth of 10%. That, by the way, is one of the major problems with YPEG valuations. I am unhappy with beta because there is growing evidence that it isn't a good surrogate for risk, but it is the best we have. So I used it with CNPEG2 and kept my fingers crossed. Finally, there is the issue of the base index. Others have suggested that the use of a sector index might be better. I have resisted the idea, but cannot give you a good reason for preferring the S&P. Maybe it's just laziness, because then I would need good numbers for each sector. Can you imagine a meaningful YPEG number for the internet stocks? That's about the extent of my thinking. I hope this helps. Please feel free to criticize my approach. Maybe with enough criticism it can be worked into something more useful. TTFN, CTC