DJIA 8712.87 -100.14 (-1.14%) S&P 500 1100.65 -5.72 (-0.52%) Nasdaq 1781.29 +8.59 (+0.48%) Value Line ndx 918.49 -5.70 (-0.62%) 30-Year Bond 106 13/32 +12/32 5.67% Yield
Reinsurance underwriter and risk management company General Re Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: GRN)") else Response.Write("(NYSE: GRN)") end if %> gained $51 1/2 to $275 in after-hours trading after announcing late this afternoon that it has agreed to be acquired by reinsurance and insurance underwriter, manufacturer, services company, and retailer Berkshire Hathaway <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BRK.A and BRK.B)") else Response.Write("(NYSE: BRK.A and BRK.B)") end if %>. GenRe agreed to swap each of its shares for either 0.0035 Berkshire class "A" shares or slightly less than 0.1050 Berkshire class "B" shares. The total value of the transaction is $22 billion, according to the Associated Press, and values GenRe at $276.50 per share, a 26% premium to today's closing price. GenRe brings a diverse array of underwriting capabilities and clients to Berkshire's already large insurance operations. Of significant note, GenRe brings over $20 billion in low-cost to no-cost "float," or funds represented by premiums that have been paid by clients but not yet paid out by the company in claims. With Berkshire trading at an all-time high and at two times its equity equivalents (net assets plus liabilities are tantamount to equity), the company's valuation is also skirting new highs. That being the case, Chairman Warren Buffett probably believed the time was right to use the equity, though he is not the type to try and give less intrinsic value than Berkshire receives, and he's also definitely not the type to give more intrinsic value than the company is receiving. Suffice it to say that he probably doesn't believe Berkshire to be undervalued at the moment.
International PC and computer products distributor CHS Electronics <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: CHSE)") else Response.Write("(Nasdaq: CHSE)") end if %> advanced $2 to $16 9/16 after saying it is "positive" about its fiscal Q2 performance. Overall sales trends are "within three percent" of the company's target for the period, with only hard-disk drives selling below plan. Moreover, chairman and CEO Claudio Osorio said gross margins are above target and operating expenses are in line with expectations. Gross margins came in at 7% in fiscal Q1, which is fairly typical for a pure-play distributor. The company has been rapidly expanding its operations worldwide, leading to a 91% compounded annual top-line growth rate over the last four years. It is also a consistent earnings surpriser, beating the Street's estimates by at least $0.02 per share over the past six consecutive quarters.
Camco <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CAM)") else Response.Write("(NYSE: CAM)") end if %> jumped $12 15/32 to $74 23/32 after agreeing to merge with a unit of fellow oilfield services firm Schlumberger <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SLB)") else Response.Write("(NYSE: SLB)") end if %> in a deal valued at about $3.1 billion. Each Camco share will be converted into 1.18 shares of newly issued Schlumberger stock, valuing Camco at a 33% premium to its closing price of $62 1/4 per share yesterday. The merger is expected to add to Schlumberger's earnings in fiscal 1999. Schlumberger fell $3 11/16 to $66 1/4 on the news, even though the deal appears to be a good fit. From Schlumberger's point of view, deriving cost-savings from the merger takes a back seat to combining its expertise in seismic data acquisition with Camco's flow control systems and submersible pumps. In this sense, the deal harkens back to Halliburton's <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HAL)") else Response.Write("(NYSE: HAL)") end if %> purchase of Dresser Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DI)") else Response.Write("(NYSE: DI)") end if %> and Baker Hughes' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: BHI)") else Response.Write("(NYSE: BHI)") end if %> recent acquisition of Western Atlas <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: WAI)") else Response.Write("(NYSE: WAI)") end if %>.
QUICK TAKES: Software giant Microsoft <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MSFT)") else Response.Write("(Nasdaq: MSFT)") end if %> rose $3 1/2 to $94 11/16 after Goldman Sachs raised its fiscal 1998 earnings estimate to $1.77 per share from $1.75 per share. Yesterday, CEO Bill Gates told reporters in Taiwan that the worldwide PC industry is still experiencing "strong" growth despite the ongoing Asian financial crisis... Number-two U.S. long-distance carrier MCI Communications <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MCIC)") else Response.Write("(Nasdaq: MCIC)") end if %> gained $1 13/16 to $56 1/2 after Britain's Cable & Wireless PLC <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CWP)") else Response.Write("(NYSE: CWP)") end if %> dropped a breach of contract lawsuit against the company. MCI merger partner WorldCom <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: WCOM)") else Response.Write("(Nasdaq: WCOM)") end if %> rose $1 5/16 to $47 1/16 on the news... Micron Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: MU)") else Response.Write("(NYSE: MU)") end if %> picked up $1 3/16 to $23 3/8 after agreeing to purchase Texas Instruments' <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: TXN)") else Response.Write("(NYSE: TXN)") end if %> dynamic random access memory (DRAM) chip business for about $800 million in Micron stock and debt.
Graphics accelerator chipset maker 3Dfx Interactive <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TDFX)") else Response.Write("(Nasdaq: TDFX)") end if %> moved up $1 to $17 after the company issued a press release reassuring investors that its shipments to number 1 client Diamond Multimedia Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DIMD)") else Response.Write("(Nasdaq: DIMD)") end if %> "will be in line with its forecasts" during the current quarter... Casino operator Circus Circus Enterprises <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CIR)") else Response.Write("(NYSE: CIR)") end if %> gained $1 5/8 to $17 7/8 after Business Week reported that casino and hotel company Hilton Hotels Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HLT)") else Response.Write("(NYSE: HLT)") end if %> is again talking to the firm about a buyout at around $28 per share... Lyondell Petrochemical Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: LYO)") else Response.Write("(NYSE: LYO)") end if %>, which makes ethylene and propylene used in plastics, rose $1 11/16 to $30 11/16 after agreeing yesterday to buy Arco Chemical Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: RCM)") else Response.Write("(NYSE: RCM)") end if %> for $5.62 billion in cash and $870 million in assumed debt.
Enterprise software developer J.D. Edwards <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: JDEC)") else Response.Write("(Nasdaq: JDEC)") end if %> rose $3 to $41 7/8 after BT Alex. Brown raised its rating on the stock to "strong buy" from "buy"... Turf and forage seed developer AgriBioTech <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ABTX)") else Response.Write("(Nasdaq: ABTX)") end if %> plowed ahead $2 15/16 to $29 after home improvement retailer Home Depot <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: HD)") else Response.Write("(NYSE: HD)") end if %> agreed to sell AgriBioTech's Lofts brand of grass seeds nationwide starting in early 1999... Upscale hardware and home furnishings retailer Restoration Hardware <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: RSTO)") else Response.Write("(Nasdaq: RSTO)") end if %> won the "hot initial public offering of the day" sweepstakes, rising $7 1/4 to $26 1/4 after selling 3.33 million shares today at $19 per share... Investment management and commercial financing company Allied Capital Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ALLC)") else Response.Write("(Nasdaq: ALLC)") end if %> moved $1 3/4 higher to $23 1/2 after Bear Stearns started coverage of the company with a "buy" rating.
Biopharmaceutical company Aphton Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: APHT)") else Response.Write("(Nasdaq: APHT)") end if %> gained $2 3/4 to $17 5/8 after signing a licensing and collaboration agreement with drug giant SmithKline Beecham <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SBH)") else Response.Write("(NYSE: SBH)") end if %> to develop treatments for certain cancers and other diseases... Electronic security systems designer ITI Technologies <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ITII)") else Response.Write("(Nasdaq: ITII)") end if %> climbed $2 3/16 to $30 1/16 after announcing a plan to buy back up to 1 million shares of its stock... Office supplies distributor U.S. Office Products Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: OFISD)") else Response.Write("(Nasdaq: OFISD)") end if %> rose $2 to $24 11/16 after saying its fiscal Q4 EPS will be in line with its previous guidance of $0.44 per share... Homebuilder Kaufman & Broad Home Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: KBH)") else Response.Write("(NYSE: KBH)") end if %> tacked on $1 7/16 to $26 3/8 after CS First Boston upgraded the company to "buy" from "hold."
Client/server applications software firm Project Software & Development <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PSDI)") else Response.Write("(Nasdaq: PSDI)") end if %> advanced $2 to $23 after an analyst told Business Week that new management at the firm could have the stock trading at $36 per share a year from now. Another analyst said Tera Computer Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: TERA)") else Response.Write("(Nasdaq: TERA)") end if %> will see dramatic near-term growth in the sales of its supercomputers, sending that firm's shares up $1 7/16 to $12 3/8... Video editing software provider Avid Technology <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: AVID)") else Response.Write("(Nasdaq: AVID)") end if %> rose $3 1/16 to $31 1/2 after Prudential Securities reiterated its "buy" rating on the stock... Freight transportation equipment leasing firm XTRA Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: XTR)") else Response.Write("(NYSE: XTR)") end if %> gained $14 15/16 to $61 after agreeing to be acquired by cargo container leasing company Interpool <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IPX)") else Response.Write("(NYSE: IPX)") end if %> and a partnership controlled by investment firm Apollo Management in a deal valued at about $1.9 billion. Interpool picked up $1 1/16 to $15 3/4.
Iomega <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: IOM)") else Response.Write("(NYSE: IOM)") end if %> sank $13/16 to $5 1/2 in heavy trading after warning that it expects a second quarter loss (before charges) between $0.10 and $0.13 per share due to weaker-than-expected aftermarket sales and a shift toward lower-margin original equipment manufacturer (OEM) sales. Analysts had been predicting a loss of $0.02. In an effort to improve its financial performance, the Zip drive maker plans to cut costs by restructuring its operations, which will include cutting 600 to 700 jobs, or about 13% of its workforce. Iomega will take a one-time pre-tax restructuring charge of $5-$10 million in the second quarter, but it believes that the revamping could save the company more than $50 million in the second half of the year. The company's goal now is to be profitable by the fourth quarter, but it doesn't expect to show profit for the year.
A day after Dreyer's Grand Ice Cream <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: DRYR)") else Response.Write("(Nasdaq: DRYR)") end if %> made an earnings warning, Friendly Ice Cream Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: FRND)") else Response.Write("(Nasdaq: FRND)") end if %>, too, announced that it expects Q2 earnings will be "significantly lower than expectations." Like Dreyer's, Friendly blamed the shortfall on unprecedented price increases for the key ingredient in ice cream -- fresh cream. After 10 years of steady decline, the market price of domestic butter, the benchmark the government uses to set cream prices, has reached historically high levels -- twice as much as the prevailing world price -- rising 50% since the end of April. Friendly said its sales also were hurt by recent cold wet weather in the areas it operates stores. Early next month, the company plans to raise prices on some of its packaged ice cream products. Dreyer's, which said the current situation may only accelerate consolidation in the ice cream industry, has already increased the wholesale price of its Dreyer's and Edy's branded products in most markets. Friendly plunged $5 1/4 to $15 3/8, while Ben & Jerry's <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: BJICA)") else Response.Write("(Nasdaq: BJICA)") end if %> lost $2 3/8 to $17.
QUICK CUTS: A day after announcing its deal to acquire a 43% stake in Infoseek <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SEEK)") else Response.Write("(Nasdaq: SEEK)") end if %>, Walt Disney Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: DIS)") else Response.Write("(NYSE: DIS)") end if %> lost another $4 7/16 to $107 9/16 as Goldman Sachs lowered its 1998 earnings estimate for the entertainment and media company to $3.00 per share from $3.10. Infoseek slipped $1 11/16 to $33 7/16... Pfizer <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: PFE)") else Response.Write("(NYSE: PFE)") end if %> fell $3 1/8 to $111 1/4 on news that health maintenance organization Kaiser Permanente won't cover the drug company's blue impotence pill Viagra in new benefits contracts. This afternoon Pfizer also announced it has received a non-approvable letter from the FDA for its anti-psychotic drug Zeldox... Sunbeam Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: SOC)") else Response.Write("(NYSE: SOC)") end if %> sank $1 13/16 to $11 1/4 after Bear Stearns cut its 1998 EPS estimate for the consumer appliances company to $0.17 from $0.60 while maintaining a "neutral" rating. Sunbeam subsidiary Coleman Co. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CLN)") else Response.Write("(NYSE: CLN)") end if %> tumbled $1 1/8 to $12 5/16.
Network server vendor Sequent Computer Systems <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SQNT)") else Response.Write("(Nasdaq: SQNT)") end if %> tanked $3 3/8 to $12 1/16 after announcing that Q2 revenue will be "significantly below" management's expectations, and that it will report a loss between $0.25 and $0.35 a share, below analysts' expectations of a profit of $0.24... Hall, Kinion & Associates <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: HAKI)") else Response.Write("(Nasdaq: HAKI)") end if %>, which hires out information technology specialists on a contract and permanent basis, plummeted $5 3/8 to $7 5/8 after warning that it expects Q2 EPS of $0.07 to $0.09 compared with $0.06 for the year-ago period and the $0.12 expected by analysts... Flash memory data storage products company SanDisk Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: SNDK)") else Response.Write("(Nasdaq: SNDK)") end if %> plunged $2 3/4 to $13 1/2 after announcing that it expects Q2 revenue will be lower than Q1 revenue and that Q2 EPS will be "marginally positive." Analysts were expecting EPS of $0.19.
Electrical and automotive products and tools and hardware maker Cooper Industries <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: CBE)") else Response.Write("(NYSE: CBE)") end if %> skidded for a $7 1/4 loss to $56 after announcing that it expects Q2 earnings to rise "modestly" from the year-earlier period but to be lower than previously anticipated... Marketing intelligence firm The M/A/R/C Group <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: MARC)") else Response.Write("(Nasdaq: MARC)") end if %> dropped $1 to $15 after announcing that it expects Q2 EPS of $0.09 to $0.11, down from last year's $0.33 (excluding non-recurring gain) and lower than analysts' expectations of $0.20... Metal-oxide programmable logic chip maker Altera Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: ALTR)") else Response.Write("(Nasdaq: ALTR)") end if %> shed another $1 3/16 to $28 13/16 after CS First Boston lowered its 1998 earnings estimate for the company... Merchant card processor NOVA Corp. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: NIS)") else Response.Write("(NYSE: NIS)") end if %> declined another $2 3/8 to $31 9/16 after yesterday announcing it will acquire merchant bankcard processing services company PMT Services <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: PMTS)") else Response.Write("(Nasdaq: PMTS)") end if %> for about $1.3 billion.
Cardboard boxes maker Stone Container <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: STO)") else Response.Write("(NYSE: STO)") end if %> was cut $1 3/16 to $14 3/4 as Prudential Securities lowered its 1998 earnings estimate for the company to a loss of $2.40 a share from a loss of $2.10 based on projections of lower-than-expected prices for linerboard... Engineering and scientific consulting firm Exponent Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(Nasdaq: EXPO)") else Response.Write("(Nasdaq: EXPO)") end if %> lost $1 1/8 to $9 1/8 after warning that it expects Q2 EPS in the range of $0.08 to $0.11 (excluding tax benefits)... Ionics Inc. <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE: ION)") else Response.Write("(NYSE: ION)") end if %> fell another $2 1/16 to $40 after Merrill Lynch downgraded its near-term rating on the water treatment systems company to "neutral" from "accumulate" on concern about certain desalination projects and the effect of the economic turmoil in Asia on sales of ultra-pure water. Merrill cut its Q2 EPS estimate for the company to $0.37 from $0.40 and its full-year estimate to $1.75 from $1.80.
FOOL
ON THE HILL
An Investment Opinion
by
Dale Wettlaufer
Why the PEG Doesn't Always Work
This may appear as blasphemy in the Motley Fool, where we talk about the price-to-earnings growth (PEG) ratio and the year-ahead YPEG, but the PEG doesn't always work. We were never married to the thing, anyway, as Tom and David have stated numerous times that it should be used as a guide, not as an absolute determinant of value. But the PEG has taken on the imprimatur of great investors and the investment establishment alike. Hey, if guys like Peter Lynch and T. Rowe Price (the actual growth stock investor, not the firm that bears his name) use it, then it must be useful, right? It works for some applications and it doesn't work for other applications.
The PEG and YPEG are ceteris paribus equations. In other words, they assume that if all other things in the environment of pricing a stock do not change, then a company's stock is fairly priced when its P/E is equal to its growth rate over some following time period. In the real world, though, it's not often that all other things outside a company's EPS growth rate remain unchanged, which renders a ceteris paribus ratio unreliable for pricing a company at its intrinsic value.
This is the conclusion of a CS First Boston survey of 28 companies covered by its technology group. The company's survey showed that the correlation between a company's year-forward P/E ratio and the company's actual compound annual growth rate in earnings over the ensuing five years was zero. There was no correlation. Now, if that doesn't satisfy the question of whether the stock was fairly priced at the beginning of the period, just take one step back from that question. If there was no correlation between the P/E and the actual EPS growth rate over the following five years, how can we price something where one completely non-correlated figure is supposed to predict the current price? As Charlie Wolf, PC hardware analyst at CS First Boston says, "We can't."
The current P/E of a stock is a shorthand measure that we really should get away from relying on as investors. The P/E is a function of the current value of a company's equity that is derived through models that look at cash flows, economic value added (EVA), net debt (debt less cash), a residual value of cash flows or EVA, and a discount rate. These models indicate an equity value for the company that is then compared to the company's current earnings, yielding a P/E. The fact that a P/E can be observed, that it exists, doesn't validate the existence of the P/E as a predictive measure. It's a descriptive measure, but not an explanatory measure. As a descriptive measure, it's not all that great either.
Let's assume we have a company that we know for certain (because we have a crystal ball that tells us so) will grow its earnings at a 40% compound rate over the next five years. The PEG model would tell us that it would be a buy at 20 times earnings, fairly valued at 40 times earnings, and a short candidate starting at 60 times earnings. If you had bought at those various P/Es and the stock were valued at 20 times earnings five years hence, your compound rate of return over the ensuing five years would be:
20 times�..40%
40 times�..21.9%
60 times�..12.4%
Intrinsic value is accepted by many to be "the present value of a security that offers a rate of return no greater or no less than the market over some ensuing time period." Since the stock market (the S&P 500 being the market proxy, though this is the cream of the crop of equities and has outperformed broader market indexes such as the Russell 2000 and Wilshire 5000) has offered rates of return of almost 20% per year over the last five years. At 40 times earnings, it appears as though the PEG worked. How convenient. However, what happens when the terminal value of the company has changed? Let's re-run the same numbers for two different scenarios:
Stock Valued at 40 times earnings at end of period
20 times�..60.8%
40 times�..40%
60 times�..29%
At all initial valuations, the company has beaten the equity market in general and the S&P 500. True, the lower the valuation, the better your performance going forward, but you could have bought this stock at anything up to 86 times earnings to perform in-line with the market over the ensuing five-year period. Return is still very much a function of the price that was paid, thank you very much, but it's also a function of price at the terminal end of the holding period.
Stock Valued at 14 times earnings at end of period
20 times�..30.4%
40 times�..13.5%
60 times�..4.6%
The stock could have been purchased at anywhere up to 30 times earnings to yield a compound annual return equal to that of the market, before taxes. Again, though, that's backing into what price is right to pay for the company.
To price it correctly, you have to have insight not just into the earnings growth of the company, but you have to have a good idea how it might be priced down the road. How it might be priced down the road will be a function of the future outlook on cash flows, the company's cost of capital, the company's capital productivity, and the growth rate of cash flows. In addition, the PEG and the term "intrinsic value" assume that your opportunity cost of capital, or the return that you forgo when you engage in another activity, is the rate of return of the market. The cost of equity capital really is either the long-run rate of return of the market (about 11%) or the yield on risk-free (U.S. government) bonds with maturities of anywhere from 10 to 30 years plus an equity risk premium times the beta of a particular stock. In the above scenarios, you could have paid ridiculous valuations and still have beaten the market going forward. Such is the gift of growth and such is the fallacy that P/E should equal growth rate or below for a satisfactory return.
As I discussed in a review of a chapter of Wharton professor Jeremy Siegel's Stocks for the Long Run, it's really the economics and quality of the business and its management that make the difference in long-run returns in equities. A company that is able to grow earnings and cash flows at rates better than its cost of capital, and is able to sustain that performance, will generate satisfactory returns for shareholders. In the end, that's what is important to the long-term rate of return in equities, as much as the price that is paid initially. If at the end of your holding period, the company is priced such that the market believes the company can't generate a return on its capital that beats its cost of capital, the returns diminish. The higher the price you paid initially, the less the returns you will experience.
The PEG should be used as a guide, not as a determinant of value. It doesn't work in predicting returns or in determining the exact price an investor should pay for a company. The price at the end of the holding period determines value as much as the price paid initially. Further, the price at the end of the holding period is a function of what it will do in the future, which depends on earnings and cash flow growth prospects, capital management philosophies of management, and the economics of a particular business and a particular industry. The value now should be a function of the value down the road, which is a function of its performance down the road from that and its value down the road from that. Thus, the PEG really doesn't work if you don't consider things outside of just earnings growth.
Related article: A Tool Called PEG, Fool on the Hill (5/14/98)
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Contributing Writers Yi-Hsin Chang (TMF Puck), a Fool Brian Graney (TMF Panic), Fool Two Alex Schay (TMF Nexus6), Fool, too Dale Wettlaufer (TMF Ralegh), Final Fool
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