By Rituraj laad(40) Yogesh Kumar(16) Sushil Kumar(50) Sandhya S(24) Sunny Jain(63)

The P/E shows how much investors are willing to pay per rupee of earnings. If we assume that all firms within a sector have similar growth rates and risk, a strategy of picking the lowest PE ratio stock in each sector will yield undervalued stocks.

In its simple form, there is no basis for believing that a firm is undervalued just because it has a PE ratio less than expected growth. As interest rate decrease (increase), fewer (more) stocks will emerge as undervalued using this approach.

The PEG ratio is the ratio of P.E to the expected growth in earnings per share. PEG = PE / Expected Growth Rate in Earnings. PEG ratios will be lower for high growth companies. PEG ratios will be lower for high risk companies.

High risk companies will trade at much lower PEG ratios than low risk companies with the same expected growth rate. Companies that can attain growth more efficiently by investing less in better return projects will have higher PEG ratios than companies that grow at the same rate less efficiently. Companies with very low or very high growth rates will tend to have higher PEG ratios than firms with average growth rates. This bias is worse for low growth stocks.

PARTICULARS abc EPS PRICE P/SH GROWTH INDUSRY P.E INDUSTRY GROWH INDUSTRY PEG RATIO IMPLIED SHARE PRICE VARIATION IN PRICE

xyz 2.05 31.48 15% 12.4 11 1.13 34.66 -3.18 3.15 26 9%

31.96 -5.96

(as on 1/4/2011) SUN TV

PE (X) = 19.5 Estimated earnings growth = 14.8% over next five years (Consensus analyst) PEG ratio = 19.5 / 14.8 = 1.32 PE (X) = 12.4 Estimated earnings growth = 28.1% over next five years (Consensus analyst) PEG ratio = 12.4 / 28.1 =0.44

Eros International

More than 1.0 is poor; Less than 1.0 is good; Less than 0.5 is excellent Hence as per our last calculation Eros International has PEG of 0.44 which is excellent.

The consensus analyst estimate of EPS growth may not be accurate The PEG ratio is best suited to the stocks with little or no dividend yield. Because the PEG ratio doesn't incorporate income received by the investor in its presentation of valuation, the metric may give unfairly inaccurate results for a stock that pays a high dividend.

For example if Sun TV is a high dividend paying stock has dividend yield of 5% Hence new PEG for this stock will be PE/ (Growth estimate + Dividend yield) = 19.5 / (14.8+ 5) = 0.9 Thus if the stock is paying dividend PEG ratio improves to good from poor.

Given that the PEG ratio is still determined by the expected growth rates, risk and cash flow patterns, it is necessary that we control for differences in these variables.