Valuation Matters
I’ve read several articles over the years that suggested valuation may not matter when buying “great companies.” I disagree completely, and so did one of the greatest investors of all time, Peter Lynch. As an example, investors thought Microsoft Corporation (NASDAQ:MSFT), Cisco Systems, Inc. (NASDAQ:CSCO), and EMC Corporation (NYSE:EMC) were “great” companies before the year 2000. The truth is, all of these companies were great, but their stock prices were far too high priced. Each of these companies is a poster child for Lynch’s comment that, if you pay too much for a blue-chip company you can still lose money.
One way to measure the relative value of dividend paying stocks is by using a ratio that Lynch used. He suggested the PEG+Y ratio as a way to compare companies. The PEG+Y is like an inverted PEG ratio, in the sense that it takes into account the yield, expected growth rate, and P/E ratio of each company. The stock with the highest combination of yield and growth, and the lowest relative P/E ratio will score the best. Unlike the PEG, with the PEG+Y, the higher the number the better. This ratio is yet another reason I believe it’s time for United Technologies Corporation (NYSE:UTX) to take a rest.
Using the PEG+Y ratio, United Tech.’s yield of 2.3% and growth rate of 13.65% gives a total expected return of 15.95%. If you take this total expected return, and divide by the forward P/E ratio of 15.32, you get a ratio of 1.04. Relatively speaking, United Tech. is a better value than Johnson Controls, with a ratio of 1.02. This shouldn’t be a surprise, since Johnson Controls has a lower yield, lower growth rate, and only slightly lower P/E ratio.
However, using these same calculations, General Electric Company (NYSE:GE) looks like a better value, as does Boeing. General Electric pays a higher yield at 3.29%, and though their growth is lower, so is their P/E ratio. Boeing has a similar yield, similar growth rate, but a lower P/E than United Tech. With PEG+Y ratios of 1.05 at GE, and 1.18 at Boeing, it’s hard to recommend putting more money into United Technologies Corporation (NYSE:UTX) at this time.
I’m not suggesting shorting the stock or anything crazy like that. However, when investors can buy equally impressive companies (GE or Boeing) at a better relative value, I would suggest investors add UTX to their Watchlist to look for a better entry point.
The article 3 Reasons It’s Time for a Rest for This Stock originally appeared on Fool.com and is written by Chad Henage.
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