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Fundamental Ratios: P/E, PEG and PEGY

Years ago, investors, stock brokers and financial advisors wanted to know the “P/E” of the equity before making a buy-decision. A low P/E meant that the stock was cheap and market forces would lead to price appreciation. The opposite theory also was considered Wall Street Fact: A high P/E represents an over-valued stock and one that would devalue in the future. If you mentioned a stock, the next question was: “What’s its P/E?” Before we go further, let’s define:

P/E Ratio or Price-Earnings Ratio– A valuation ratio that compares the price of a stock to its per share earnings:

P/E Ratio = Price per Share/Earnings per Share (EPS)  

If the previous 4 quarters of earnings are used, it is referred to as trailing P/E. If the expected next 4 quarters are used, it is called forward P/E

The problem I noticed right from the getgo was that many of the companies with high P/Es back in the early 1990s, were the ones that performed the best. These were the growth companies. Institutional investors were willing to pay more for these companies, driving up prices, due to the expectations that earnings will be increasing. Peter Lynch, in his book, One Up On Wall Street, addressed this issue by stating that “The P/E ratio of any company that’s fairly priced will equal its growth rate“. He adds, ….”every stock price carries with it a built-in growth assumption”. So, if the P/E = Growth, the stock is fairly priced no matter what the P/E is. Enter the PEG ratio

PEG Ratio:  

PEG = PE Ratio/Annual EPS Growth  

Once again, the PE can be trailing or projected and the EPS Growth can be expected growth for the next one year or five years. Yahoo Finance uses a 5-year expected growth rate and an averaged PE when calculating PEG and later in this article I will give you information as to how to access this information. In general, a lower PEG is better and a PEG of  ”1″ is considered to represent a fairly valued equity. This is not a scientific number because it is based on expectations. However, to neglect totally, the fact that there should be corporate earnings growth, is rendering the P/E ratio useless especially for growth companies. The IBD 50 has many growth companies rendering the PEG much more pertinent than the PE ratio. 

Disadvantages of the PEG Ratio

  • Larger corporations offer higher dividends and less growth opportunities
  • Does not relate corporate growth to overall growth of the economy
  • Inflation is not factored in
  • Growth projections may not be accurate

Despite these limitations, in the eyes of this investor, the PEG is of much greater application to us as we write calls predominantly on high growth companies. In addition, we can more accurately compare companies in different industries. If a stock has a high PE in a high growth industry, PEG will level the playing field with a low-PE stock in a slower growth group. Please note that if a company offers dividends, the PEG Ratio does NOT take this into account and therefore renders the PEG less applicable for these companies. So how do we account for companies that provide dividend income? Enter the PEGY Ratio

PEGY Ratio

PEGY = PE Ratio/ Expected Earnings Growth + Dividend Yield 

Where to access this information

Go to http://finance.yahoo.com/ 

Type in stock ticker and “get quote” 

In left column, under “Company” click on “key statistics” 

Below is an example of the page with these stats: 

PEG and PEGY Ratios
                                                       PEG and PEGY Ratios 

Circled in red is the PEG based on a 5-year expected growth rate and circled in green is the projected dividend yield for calculating PEGY ratio. 

What Fundamentals does the BCI System Utilize?: 

Plenty…although it doesn’t take us all that long to calculate. First, let’s look at the IBD 50 stocks and the fundamentals evaluated: 

  • Return on Equity
  • Earnings per Share rating
  • Annual EPS % change
  • Last Quarter EPS % change
  • Next Quarter EPS % change
  • Last Quarter Sales % change

In addition, we run the stocks through the SmartSelect (Green Alert) ratings. The “EPS Rating” compares a company’s earnings per share growth on both a current and annual basis with other publicly traded companies. It compares the company’s most recent two quarters of EPS growth with its 3-5 year annual growth rate. 

Furthermore, the Scouter Rating factors in many of the fundamental qualities of equities that have proven statistically to be predictive of stock performance in the past. In other words, we have all bases covered when it comes to fundamental ratios and analysis

Event update:

I will be presenting a FREE seminar on Tuesday July 12th @ 7PM for the Long Island Stock Traders Meetup Group. The topic is “Using Covered Call Writing to Increase Dividend Yield of High Dividend Yield Stocks”. You do not need to be a member of this club to attend. It will be held in a huge state-of-the-art auditorium at The Plainview-Old Bethpage Public Library:

999 Old Country Road

Plainview, NY 11803

Hope to see you there.

Market tone:

Once again we experienced a week of mixed economic reports:

  • The Federal Reserve downgraded its 2011 GDP forecast to 2.8% from 3.2%
  • The FOMC left its target fed funds rate at between 0% and 2.5% “for an extended period of time.”
  • The 1st quarter GDP grew at an annual rate of 1.9% a slight upward revision
  • The FOMC noted that “core” long-term inflation remains stable
  • Sales of new homes dropped by 2.1% in May while the supply of unsold homes declined to 6.2 months, the lowest since mid-2010
  • Sales of existing homes dipped 3.8% in May for the 2nd consecutive month
  • New orders for durable goods advanced 1.9% in May after dropping 2.7% in April

For the week, the S&P 500 fell by 0.2% for a year-to-date return of 1.8% including dividends.

In November of last year I published an article discussing yield curves. Here is a paragraph from that article:

Steep Curve: Steep Yield Curve- 1992

This results when we have a greater-than-normal gap between the shorter and longer term treasuries as we see here in April of 1992. This marks the beginning of an economic expansion shortly after a recession. By 1993, the GDP was expanding by 3% per year and by the following year short-term interest rates had increased by 2 percentage points. That’s why investors were demanding greater long-term returns. Those investors who used this curve to increase their stock holdings were rewarded with a 20% return over the next two years (Russell 3000).

Next let’s take a look at the current yield curve:

Yield Curve as of 6-23-11

Many economists consider the yield curve the most important leading economic indicator and it is telling us that a double-dip recession is not on the horizon. This will eventually lead to banks borrowing short term and lending long term once they have recovered from their excesses of 2008. Historically, the yield curve has been the first of the leading indicators to signal a change in the business cycle. The past 7 expansions lasted 71 months on average and the current one is not even two years in the making. It is impossible to predict markets with 100% certainty but to ignore history is a mistake Blue Collar Investors refuse to be guilty of.

Summary:

IBD: market in correction

BCI: This site remains cautiously bullish on the economy but hedging by selling predominantly in-the-money strikes due to the short-term volatility.

The best in investing to all,

Alan (alan@thebluecollarinvestor.com)

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About Alan Ellman

Alan Ellman loves options trading so much he has written four top selling books on the topic of selling covered calls, one about put-selling and a sixth book about long-term investing. Alan is a national speaker for The Money Show, The Stock Traders Expo and the American Association of Individual Investors. He also writes financial columns for both US and International publications along with his own award-winning blog.. He is a retired dentist, a personal fitness trainer, successful real estate investor, but he is known mostly for his practical and successful stock option strategies.

30 Responses to “Fundamental Ratios: P/E, PEG and PEGY”

  1. Barry B June 25, 2011 7:30 pm #

    Premium Members,

    The Weekly Report for the week ending 6/24/11 has been posted to the Premium Member website.

    Best,

    BB

  2. Barry B June 25, 2011 10:59 pm #

    Premium Members,

    A revised report has been uploaded…6/24/11-REVA. Made a minor typo…sorry for the extra work.

    Best,

    Barry

  3. Ron P. June 26, 2011 8:43 am #

    I read that Alan is presenting a dividend yield idea relating to CC:

    I will be presenting a FREE seminar on Tuesday July 12th @ 7PM for the Long Island Stock Traders Meetup Group. The topic is “Using Covered Call Writing to Increase Dividend Yield of High Dividend Yield Stocks”. You do not need to be a member of this club to attend. It will be held in a huge state-of-the-art auditorium at The Plainview-Old Bethpage Public Library:

    Here is a trade which I placed on Friday:
    1) Bought T (ATT) @ 30.56
    2) Sold the April 21 2012 Call for a deep in the money price strike of $26 for $4.65
    3) There will be (unless the stock is called) four dividends of $.43 each quarter or $1.72
    4) The investment is $30.56 minus $4.65 or $25.91
    5) The simple yield (no day count ) is thus 1.72/25.91 = 6.64%
    6) There is another small piece of return from the exercise of the call as the sum of the call and the strike is $30.65 or $.09 ( .35% )more than the stock price of $30.56
    7) The call date is April 21 2012 and it looks like the four dividend will be of record by that time:
    Amount Ex-Dividend Date Record Date Pay Date Declare Date Qualified? [?]
    Type
    T has not yet announced its next dividend payout.
    $0.43 4/6/2011 4/8/2011 5/2/2011 3/25/2011 Yes Regular
    $0.43 1/6/2011 1/10/2011 2/1/2011 12/17/2010 Yes Regular
    $0.42 10/6/2010 10/8/2010 11/1/2010 9/24/2010 Yes Regular
    $0.42 7/7/2010 7/9/2010 8/2/2010 6/25/2010 Yes Regular
    8) So the hold period will be June 24, 2011 through April 21, 2012 or 302 days
    9) Thus the total yield looks like ($1.72/(30-4.65))*(365/302)= 8.44%
    10) The downside protection is 4.65 point or 15.22% (excluding the dividends received).
    Any comments, please?

  4. Ron P. June 26, 2011 9:00 am #

    9) Thus the total yield looks like ($1.72/(30-4.65))*(365/302)= 8.44%

    Should read ($1.72/(30.56-4.65))*(365/302)= 8.44%. The little extra yield from line 6) was also considered for those who get a slightly smaller overall yield of 8.02%

  5. Karen June 26, 2011 11:44 am #

    Alan,

    Can you recommend a free site that gives updated information on the current yield curve? I like the idea to include this in my market evaluation.

    Thank you.

    Karen

  6. admin June 26, 2011 2:35 pm #

    Ron (#s 3 and 4),

    Your math is fabulous. For new members Ron is using longer term options to reduce his cost basis to increase the dividend yield of “T”. I have alluded to this strategy recently using LEAPS options. Our main concern with this strategy is the chance of early exercise (the day before the ex-dividend date). If this occurs you will not receive the dividend and your only profit will be the small amount of time value from the initial option sale. You will not loose money. I have been speaking with hedge fund managers and a former options market-maker to determine a common sense set of guidelines to determine in advance the chances of early exercise. Here are the factors that are important:

    1- Delta of the option

    2- Time to expiration

    3- Time value of the option as it relates to the dividend

    Here is a link to an article I published a few months ago:

    http://www.thebluecollarinvestor.com/blog/using-covered-calls-to-increase-dividend-yield/

    Alan

  7. admin June 26, 2011 4:41 pm #

    Karen (# 5),

    Stockcharts offers a free updated version of the yield curve and allows you to compare it to the S&P 500 in different time frames:

    http://stockcharts.com/freecharts/yieldcurve.html

    Alan

  8. Ron P. June 27, 2011 7:54 am #

    Could you provide a bit of insight into the sale price of the call when the spread is $.40 instead of $.10. How should we place our order to narrow the spread? Most broker when we initiate a CC transaction (buy stock & sell call at the same moment) charge a single commission (TD Ameritrade $9.95). Thanks in advance.

  9. Ron P. June 27, 2011 8:04 am #

    One more issue: ex-dividend and record day. I have read that the dividend receiver is controlled by the owner of the stock on the record date, and I have read that the dividend receiver is controlled by the ex-dividend date.
    Here is a writing I have read this AM…

    Why do Ex-Dividend Dates Matter?

    A dividend-paying stock’s ex-dividend date is very important to investors. In a nutshell, if you buy a dividend stock before the ex-dividend date, then you will receive the next upcoming dividend payment. If you purchase the stock on or after the ex-dividend date, you will not receive the dividend.

    The converse of this rule also holds true — if you sell a stock before the ex-dividend date, you will not receive the dividend, but if you sell on or after the ex-dividend date, you will.

    Is this correct or is the control of the dividend with the “record date owner”?

  10. admin June 27, 2011 3:43 pm #

    Ron (#8),

    A guideline I use is to divide the bid-ask spread in half and drop down a bit in favor of the market-maker. In your example of a $0.40 spread: divide in half ($0.20) a drop down another $0.05 for a final limit order $0.15 above the current published bid. If you are using a combination form simply put a limit order below the published debit amount. For example if the debit is $28, set a limit of $27.85. Over the years this approach will put significant cash in our accounts.

    ***Remember NOT to check the “All or None” box on your execution form.

    Alan

  11. Fred June 27, 2011 4:29 pm #

    Ron,

    I am under the impression that the ex-dividend and record dates are the same. If you own a stock prior to the ex date, you receive the dividend.

    Fred

  12. Ruth June 27, 2011 5:29 pm #

    Alan,

    I just started reading Cashing in on Covered Calls and I’m finding it really easy to understand but do have one question. I hope you can explain what you mean by ” out of the money strike prices offer no downside protection”.

    Thanks for your help.

    Ruth

  13. Ron P. June 27, 2011 6:02 pm #

    Thanks for the clear explanation of the process to handle the wide spread between bid and ask. Very clear,
    Regards

  14. admin June 27, 2011 8:27 pm #

    Ron (#9),

    I agree with Fred. Shareholders who have properly registered their ownership prior to the record date will receive the next dividend. This registration is automatic for shares purchased prior to the ex-dividend date.

    Alan

  15. admin June 27, 2011 8:30 pm #

    Ruth (#12),

    I focus on profit or the time value of the premium. O-T-M strikes offer no protection of the TIME VALUE of the option premium. This differs from the “breakeven” which is always
    the purchase price minus the total option premium. I’m not interested in breaking even!

    Alan

  16. admin June 28, 2011 6:43 am #

    Premium members:

    This month’s list of high dividend yield stocks with LEAPS has been uploaded to your premium site. Look for the report dated June-July-2011 in the resources/downloads” section.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    Not a premium member:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  17. Ron P. June 28, 2011 7:19 am #

    admin (#16)

    WARNING: BKS (Barns and Nobles)
    This stock suspended its dividend payouts on 2/22/11.

  18. admin June 28, 2011 8:01 am #

    Thanks Ron. Makes sense. Many of these book stores are experiencing trying times with the growing popularity of kindles and similar devices. I’ll have my team remove BKS from our list.

    Alan

  19. Meryl June 28, 2011 8:12 am #

    Alan,

    Do you ever consider going out 2 months on your options if the company recently reported earnings?

    Thank you.

    Meryl

  20. owenCPA June 28, 2011 1:29 pm #

    Ruth #12,

    Alan and the BCI use the expression “downside protection” when we are discussing an in-the-money option. It works like this:

    Say I buy 100 shares of a stock for $27 and choose to sell the $25 call for $3.50. I am receiving $2 of the $3.50 premium simply because the option is In-The-Money. We refer to it as downside protection because, if the stock drops $1, or even $2, we will not lose a cent. We already expect the stock to get called away at $25. This is also why we do not consider the intrinsic value to be “profit”, because it is not. If I buy the stock at $27, sell the $25 call for $3.50, I can only gain $1.50 if the stock gets called away. The other $2 was money I just laid out for the stock when I bought. Think of it as a downpayment on the purchase.

  21. Ted June 29, 2011 6:36 am #

    With the mnarket up nicely so far this week and futures looking good this morning I was wondering what criteria you use to start getting more aggressive wtih out of the money strike options.

    Thanks.

    Ted

  22. admin June 29, 2011 12:29 pm #

    Ted,

    Strike selection is dependent on one’s market and equity assessment and risk tolerance. What’s right for me or you may not be right for another. That being said, here is my approach:

    I view the charts of the S&P 500 and the VIX and follow weekly economic reports. When the market tone is bullish and equity technicals are positve I favor out-of-the-money strikes. When the market has a bearish or volatile tone and stock technicals are mixed I favor in-the-money strikes. As the parameters move one way or the other I will mix (ladder) the strikes depending on the direction. Because of my conservative nature I tend to favor in-the-money strikes longer than those who are more aggressive. Each week in my blog articles I will comment on my strike selection with the understanding that my approach is an extremely conservative one.

    Alan

  23. Ted June 30, 2011 6:47 am #

    Thanks Alan. It is tempting though with the market up 3 days in a row and the futures looking good again this morning. I’ll try not to let emotions get the best of me!

    Ted

  24. Meryl June 30, 2011 11:57 am #

    If a stock price is well above the strike price is there anything we could do to capture some of that profit?

    Thank you.

    Meryl

  25. owenCPA June 30, 2011 2:33 pm #

    Meryl #24,

    Yes, if you still have faith in the stock. You can buy back the call you sold, which will have little, or no, time premium left, and sell a higher strike price call, either for the same month, or the next month out. This should be done only for a stock you believe still has more upside potential, otherwise you risk giving up the gain you already had, and perhaps more.

    I view my positions with two numbers in mind, the gain I already have, and what I have left to make. Example: this morning I closed out an Apple trade. I had already built a paper gain of $158, but based on the prices this morning there was only the potential to earn another $42 in the next three weeks. Why tie up the money for another $42?

    So, I closed the position and opened a new one, getting $410 in the process, with the same three weeks to go. So, which is better? Keep $3,000 tied up to gain that last $42, or use it for another position that may return $410 in the same time period. I hope I didn’t really have to ask that question.

    When you evaluate your current positions you MUST look at them with an eye on WHAT YOU HAVE LEFT TO EARN. It should be a very important piece of your “hold or close” decision. Again, a very simple rule of thumb might be, l0ok at the position as if you did not already own it. The stock you bought at $34, is now $39. The $35 call you sold for $1.43 is now $4.20. That means you have the potential to earn the last $0.20 in the next three weeks. Question: would you invest $3,900 in that stock to earn $20 over the next three weeks? Yes, keep it. No, move on. Buy back the $35 and sell the $37.50 or $40 call. Close it out completely and pick another prospect off your watch list. Close it out completely, smile smugly at your spouse, and say, “I told you BCI was a good idea.”

  26. admin June 30, 2011 2:37 pm #

    Meryl,

    Adding to Owen’s comment:

    There is a lot of good news associated with the scenario you present:

    1- You have (to this point) achieved your goals of a great 1-month option return + share appreciation to the strike price had you sold an out-of-the-money strike.

    2- If your stock price is well above the strike, that profit is proteced from the current market value down to the strike price.

    3- If the time value of the current option price approaches zero, we can invoke the “mid-contract unwind” exit strategy where we buy back the option, sell the stock and use the cash to set up a new covered call position and a second income stream in the same month with the same cash.

    Alan

  27. admin June 30, 2011 6:42 pm #

    Premium members:

    This week’s 6-page report of top-performing ETFs and analysis of ALL Select Sector Components has been uploaded to your premium site.

    For your convenience, here is the link to login to the premium site:

    http://www.thebluecollarinvestor.com/member/login.php

    Not a premium member? Check out this link:

    http://www.thebluecollarinvestor.com/membership.shtml

    Alan and the BCI team

  28. admin July 1, 2011 5:56 am #

    ACN:

    On June 28th this recent entry to our premium watch list announced that Standard & Poor’s will add Accenture’s common stock to the S&P 500 Index after the close of trading on Tuesday, July 5. Mutual funds and ETFs that reflect this benchmark will be required to purchase these shares based on its market capitalization. Our premium report shows this stock has an industry segment rank of “B”, a beta of 0.77 and a dividend yield of 1.60.

    Alan

  29. admin July 1, 2011 11:38 am #

    HOC = HFC:

    HOC, a stock on our premium watch list is now trading under the ticker symbol HFC as a result of a recent merger. If you own HOC the only change is the name as the number of shares remains the same and there is no cash settlement either way. If you own this stock please change the ticker symbol in your portfolio manager list.

    Alan

  30. Kevin July 2, 2011 9:04 am #

    Alan,

    Thanks for that last post. I was wondering why I couldn’t pull up any information on this stock. By the way, this stock has been a big winner for me the past few months. Keep up the good work.

    Kevin

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