(March, 2004)
Employing the “P.E.G. Ratio” in your Stock Selection
In recent years, bullish stock market investors have come up with some pretty creative ways to justify the historically high valuations of their holdings. Given the market’s woes during the first few years of this new decade, many of them have properly been rebuked; though lately it looks like some of the more interesting ways investors can rationalize overvalued stocks have made a comeback.
Rather than pontificate any further on this subject, though, I want to share with you one of the newer tools for measuring the valuation of stocks that actually is a viable one; and one that can save you from buying the wrong stocks. It is referred to as the PEG ratio.
Historically, one measure that investors have used to evaluate stocks is the price-earnings, or P.E. ratio. You can come up with this by dividing the price of a company’s stock by its most recent annual earnings. For instance, if a company’s shares are currently selling for $10.00 each and that company in the latest year earned 50 cents per share, its P.E. ratio is 20:1, or simply 20.
Given that the average historical P.E. ratio for the stock market has been in the neighborhood of 15 or so, one might look at a stock with a higher P.E. ratio with some suspicion—and appropriately so. However, if the company in question is growing its annual earnings fairly rapidly—or is soon expected to do so—it might still be attractive. In the alternative, one with a P.E. ratio lower than 15 might not be worthwhile, if it is growing its earnings little, if at all.
This is where the P.E.G. ratio comes in. To calculate this—and add one useful criteria to your stock selection regimen—you simply divide the P.E. ratio by the rate of earnings growth the company in question is experiencing. The result will give you a number that is the stock’s P.E.G. (price-earnings to growth) ratio. Generally, a P.E.G. ratio of 1.0 means a stock is fairly priced. A P.E.G. ratio below 1.0 means a stock is attractive. Last—and least—a P.E.G. ratio above 1.0 suggests that a stock is too expensive.
Let’s illustrate this with a couple “real life” examples. The well-known conglomerate General Electric (NYSE-GE) recently traded at around $33.00 per share. Given its expected 2004 earnings of around $1.55 per share, that translates into a P.E. ratio of 21.29.
Assuming analyst estimates are close, G.E. will earn somewhere in the neighborhood of $1.75 in 2005. Thus, its growth in earnings year-over-year would come in at around 13 percent.
Dividing the P.E. ratio of 21.29 by 13 percent gives us a P.E.G. ratio of around 1.64, suggesting that—all other things being equal, and assuming the analyst estimates prove close to correct—General Electric shares aren’t exactly cheap!
Next, we’ll look at Tidewater, Inc. (NYSE-TDW), one of the world’s leading marine transport and oil services companies, and a past successful pick of ours. It also was recently trading at around $33.00 per share. Given estimated 2004 earnings of $1.15 per share, that translates into a P.E. ratio of 28.69, or somewhat higher than that for G.E.
The difference between the two, though, is in the picture for future earnings growth. Given the strength of energy markets, Tidewater’s earnings are expected to jump to around $1.60 per share in 2005, representing impressive year-over-year earnings growth of 39 percent.
Dividing Tidewater’s P.E. ratio of 28.69 by 39 gives us a P.E.G. ratio of around 0.74. Thus—though its current P.E. ratio is actually higher than that of G.E.—Tidewater’s stronger expected earnings growth reveals a much different picture!
In general, experts in the stock market who are particularly classified as value-oriented investors advocate that, in picking stocks for your own portfolio, you focus chiefly on those whose P.E.G. ratios are below 1.0; and the farther, the better!
“Refinance” your Life Insurance
The last few years have seen a surge in mortgage activity. This is true not only because more and more Americans have been buying new homes. In addition, people in increasing numbers have been refinancing their existing real estate. Mortgage rates at their lowest levels in decades have made it profitable to refinance a home in spite of the transaction costs associated.
What has received virtually no attention, though, is that a major change in the insurance industry has made it profitable for millions of Americans to “refinance” their life insurance, and save hundreds if not thousands of dollars in the process.
In late 2003, the life insurance industry did something it had not done in nearly a quarter of a century. It updated the mortality tables it bases its life insurance costs on. This is one of the most important factors in determining how much you pay for a term policy or, in the alternative, how much of your premiums are devoted to insurance costs if you own any type of policy that builds a cash value.
What this means to you as a consumer is important to understand. With Americans living much longer life spans, the adoption of updated mortality tables means that the cost of insurance has gone down. Keep in mind, though, that your existing life insurance is a contract; and in spite of new mortality tables applying to new policies, yours likely does NOT benefit!
Together with the intense competition in the industry for your business, rates on new policies are now in many cases considerably lower than those same policies cost just a few years ago. This opens the door for an opportunity for millions: “refinancing” life insurance!
There are many factors to weigh in this decision; ones you should consider with the help of a qualified professional. Clearly, though, this is a development which SHOULD be investigated, as the financial benefit over a period of time can be considerable!
Chasing The Oracle’s Tail Can Be Risky!
I don’t know about you, but I’ve been bombarded lately by everyone and his brother pitching their favored investment regiment to capitalize on the decline in the U.S. dollar. With the release in recent days of Berkshire Hathaway’s annual report and the long-awaited words of wisdom from its leader, Warren Buffett, these promotions have become an avalanche!
Specifically (as you already know, unless you live in a cave) the various come-ons, in effect, suggest that if buying foreign currencies is good for The Oracle of Omaha, it’s good for you. After all, with a reported $12 billion bet on foreign paper, Buffett is signaling his belief that the dollar is headed lower over time.
The trouble is, this is incredibly old news. For those of you who read something more than some promoter’s hyped-up version of BH’s latest missive, you know that many of these positions are better than a year old! You may also remember that it’s been months since Buffett pointed out that he had added to dollar-contrary plays first entered into in 2002.
Now, I do not point all this out to say that the long-term trend for the dollar has reversed. I do, though, feel compelled to add some caution to people’s thinking that what Warren Buffett has already long since done is what YOU should be doing NOW. In fact, I’ll go so far as to say that the incredible prevalence of pitches being thrown at investors to buy foreign currencies and the like suggests that, for now, the dollar will RISE rather than fall.
Some have been down the road before in chasing Warren Buffett’s tale. Several years ago, with the price of silver down around $4.00 per ounce, Buffett bought a bunch of the junior precious metal. Since then, promotions for silver have almost always urged you to buy because Buffett did; never mind that silver now might be $5,00, $6.00 or (lately) $7.00 an ounce. Never mind that much of silver’s recent rise owes to hedge funds and other speculators, and is thus suspect. Never mind that—for all we know—Buffett might have already sold or is selling now; something we might not know until next year’s report.
In the recent past, financial news outlets like CNBC were chronicling the dollar’s woes every day; and, in some cases, several times per day. Now we have all this Buffett news, with the rapid-fire promotions as to why we need to bet against the dollar.
Can you say, “contrary indicator?”
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