When Is The PEG Ratio Superior To The P/E Ratio? Part 2

The PEG Ratio-Real-Life Examples

The primary reason that I use any valuation metric is to help me make reasonable and sound buy, sell or hold decisions for my stock portfolios.  In this respect, my application of valuation methodologies is practical rather than philosophical.  In short, I am not interested in debating what valuation metric is the best.  Rather, I am interested in any valuation metric that can assist me towards making intelligent decisions under real-world applications.

For fast-growing companies (true growth stocks) I have found that the PEG ratio – when used appropriately – works quite well. Below are just a few examples to corroborate my thesis.  On each historical graph the orange valuation reference line represents a PEG ratio of 1.  A PEG ratio of 1 indicates that the P/E ratio of the orange line is equal to the company’s historical earnings growth rate.

As the reader reviews each of these graphs, take special notice of how the orange line represents a practical and sound valuation reference. However, the reader should also note that when growth is as fast as found in the following examples, you cannot really overpay to invest in any of them if you hold it long enough.  The power of compounding at high rates of growth is truly powerful.

LKQ Corporation (NASDAQ:LKQ)

LKQ has achieved an earnings growth rate of 24.2% per annum since it went public.  It is clear that a PEG ratio of 1 or a P/E ratio of 24.2 represented sound valuation. More importantly, stock price has tracked that valuation reference about as perfectly as you could expect.

However, when you view LKQ Corporation (NASDAQ:LKQ) since the beginning of 2009, you discover that its earnings growth rate has somewhat slowed down to 20.7% per annum.  This indicated a reset of the PEG of 1 to 20.7 from its previous 24.2 level on the longer-term graph.  But most importantly, this represented a highly correlated valuation reference over this timeframe.