Ask a Fool: Can I Measure a Company's Growth Potential Based on P/E Ratio? | Summary and Q&A

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June 19, 2013
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The Motley Fool
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Ask a Fool: Can I Measure a Company's Growth Potential Based on P/E Ratio?

TL;DR

PEG ratio adjusts PE ratio for growth potential, vital for assessing stock value.

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Key Insights

  • 🥳 PEG ratio combines PE ratio with expected growth for better stock valuation.
  • 🥳 Amazon's high P/E and PEG ratios result from heavy investments in growth initiatives.
  • 🥳 Established companies like Coca-Cola may have higher P/E ratios due to stability and longevity.
  • ☠️ Newer companies like Intuitive Surgical may exhibit higher growth rates but uncertain prospects.
  • 🥳 Long-term growth potential should be weighed against short-term metrics like P/E and PEG ratios in value investing.
  • 🥳 Companies purposely lowering their earnings to invest in growth strategies can skew their P/E and PEG ratios.
  • 🥳 PEG ratio provides a more nuanced approach to assessing value than traditional PE ratios.

Questions & Answers

Q: What is the PEG ratio, and why is it important for investors?

The PEG ratio, calculated by dividing PE ratio by expected growth rate, helps investors assess a stock's value considering growth potential, crucial for making informed investment decisions.

Q: How does Amazon's heavy investment in growth impact its P/E and PEG ratios?

Amazon's focus on growth through investments like subsidizing memberships and developing new products artificially inflates its P/E and PEG ratios, signaling potential overvaluation in the short term.

Q: Why do established companies like Coca-Cola and Procter & Gamble tend to have higher P/E ratios?

Established companies with consistent earnings and long-term stability may have higher P/E ratios due to lower growth prospects but offer reliability and longevity, making them valuable investments.

Q: How do newer companies like Intuitive Surgical and Salesforce impact P/E and PEG ratios?

Newer companies with uncertain future prospects may project higher growth rates, affecting P/E and PEG ratios, but the risk of uncertainty should be considered when evaluating their investment potential.

Summary & Key Takeaways

  • PE ratio measures stock price relative to earnings.

  • PEG ratio incorporates expected growth rate for better valuation.

  • Amazon's high P/E and PEG ratios due to heavy investment in growth strategies.

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