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

When evaluating LKQ Corporation (NASDAQ:LKQ) based on forward estimates for the next 3 to 5 years, we still apply the P/E equal to earnings growth rate or PEG ratio of 1.  However, future expectations have reset the PEG ratio of 1 to a P/E ratio of 17.67 based on expected earnings growth.  Consequently, the current PEG ratio is 1.12 calculated by dividing the current indicated blended P/E ratio of 19.6 by the forecast growth rate of 17.67%.  I like the visual better than I do the statistic.

As previously stated, one of the biggest criticisms of the PEG ratio is that it is based on estimates of future growth.  However, in the case of LKQ, analysts have amassed an excellent record of forecasting this company’s earnings within a reasonable range of error.  Consequently, I have a high level of confidence that those forecasts could be within a reasonable range of accuracy.  Therefore, I would consider this growth stock reasonably valued based on its attractive PEG ratio.

Express Scripts Holding Company (NASDAQ:ESRX)

As I did with my first example, I will present Express Scripts over different historical timeframes in order to address the important point that a reader expressed in part 1 of this series as follows:

“5) The PEG for a company can change over time by changes in the growth estimate and the PE. The relative change in growth over time matters.”

Since 1997, Express Scripts produced an average annual growth rate of earnings of 26.5%.  Up through the Great Recession this P/E ratio of 26.5 (PEG ratio of 1) represented a highly correlated valuation reference.  However, since 2011 the market has clearly implied a lower valuation to the shares of Express Scripts.