Tuesday, July 16, 1996
The DPEG Revisited
by MF DowMan

Those of you following the Dow Dividend Approach and our weekly updates in the Dow Statistics Center might have noticed a different look surrounding the DPEG Ratio this past week. In an effort to make the measure even easier to use, we've reformulated it slightly, but the essential character of the ratio remains the same.

Rather than coming up with a somewhat arbitrary ratio, we've changed the computation to mirror the YPEG approach which arrives at a price target for the stock. The only difference, of course, is that the DPEG takes into account a company's dividend yield as well as its projected growth rate.

Let's run through a quick example of the math:

According to First Call's consensus estimates (which you can get at Keyword:Earnings), Philip Morris <% if gsSubBrand = "aolsnapshot" then Response.Write("(NYSE:MO)") else Response.Write("(NYSE:MO)") end if %> is expected to grow at 15% a year over the next five years. And the 1997 earnings are estimated at $8.92 per share. To calculate the YPEG price target, you multiply the growth rate and the forward estimates. For Philip Morris, that gives us a YPEG price target of $133.80.

But with large-cap stocks which also pay hefty dividends, the YPEG leaves the important yield element out of the equation. The DPEG accounts for it by adding the current yield to the growth multiplier. So instead of simply multiplying the forward earnings by the growth rate, the DPEG adds the yield to the growth rate, then multiplies that sum by the forward earnings estimates. With Philip Morris currently paying a 3.98% dividend yield, the DPEG price target can be calculated this way:

(Growth + Yield) * Forward Estimate = DPEG Price Target

(15 + 3.98) * 8.92 = $169.30

By incorporating the dividend yield, then, we get a price target over the next twelve to eighteen months of $169. With the stock trading at $100.63 today, theoretically there is approximately 68% of growth potential for Philip Morris.

One word of caution. We don't have any historical data to support this theory, so use caution when making your decisions based on the DPEG. There are lots of data to support the idea that dividend yield is the best single factor to consider when looking for value in large-cap stocks, which is why we urge the Dow Dividend Approach so consistently in The Motley Fool. But as a secondary screen, the DPEG might make an interesting companion.

One possibility I'd like to test in the future (and it would have to be done as we go rather than back-testing it since old growth estimates are nearly impossible to find) is to take the top ten Dow stocks as we do now for the standard Dow Approach and then rank them by the potential they show based on the DPEG. Then we could compare that to the traditional practice of ranking those high yielders by low share price. For now, though, I'll continue to post the numbers in the Dow Statistics Center for anyone interested in following along. Fool on!

Transmitted: 7/16/96