Benchmarking the PEG Ratio

Abstract

This article argues that, to properly employ the PEG ratio criterion for the determination of under/overvalued shares, the traditional benchmark of 1 is not appropriate and the benchmark employed must be customized to the share, i.e., it must reflect that share’s specific EPS growth rate and cost of equity. Invoking the constant growth model of share valuation, a formula for the suitable benchmark is developed. Graphs which illustrate the functional dependence of the benchmark on its determinants are presented, and the errors induced due to the use of the incorrect customary benchmark of unity are investigated.

TOPIC: Security analysis and valuation