Introduction
Each Parity PEG Price Report provides high level analysis for a company listed on the London Stock Exchange (LSE). The report is typically produced or updated soon after a relevant RNS (Regulatory News Service) announcement. Relevant announcements include AGM Statements, Trading Statements and Updates as well as Interim and Final Results. It is likely that an updated Broker note (which I get from Research Tree) has also been produced.
The Companies
The companies analysed are usually ones in my universe (I will document this in more detail soon). Basically, the company will almost always already be profitable and have a Market Cap between £30m and £500m. Companies from the Industry groups, Coal, Oil & Gas, Oil & Gas Related Equipment and Services, Renewable Energy, Uranium, Metals & Mining, Industrial Conglomerates, Holding Companies, Insurance, Real Estate Operations, Residential & Commercial REITs and Collective Investments will typically be excluded. It just seems that non-profitable, smaller and larger companies and those in the Industry groups mentioned are not suitable to this type of analysis.
The Data
The analysis for each company is based on data obtained from Stockopedia. Where available the data from the most recent Broker note (from Research Tree) is also used. Typically, the data from the most recent Broker note will take precedent over the data from Stockopedia.
The Analysis Approach
The primary focus of the analysis in each report is the PEG Ratio (PEG). The objective is to identify a 1 Year and 2 Year fair value price based on the PEG and the forecast EPS growth. The PEG was made popular by Peter Lynch. In very basic terms it is calculated by dividing the PE Ratio (PER) by the Annual EPS Growth Rate. A company with a PEG of 1 is considered fair value, a PEG <1 undervalued and a PEG >1 overvalued. Thus, a company with a PER of 10 and an Annual EPS Growth Rate of 10% would have a PEG of 1 and would be considered fair value. A company with a PER of 10 and an Annual EPS Growth Rate of 20% would have a PEG of 0.5 and would be considered undervalued. A stock with a PER of 10 and an Annual EPS Growth Rate of 5% would have a PEG of 2 and would be considered overvalued. For further familiarisation with PEG, Google and the One Up On Wall Street book by Peter Lynch are valuable resources.
Note: These calculations exclude discretionary observations such as Net Debt/Cash and Dividend Yield.
So, the next 2 years EPS forecasts (Year 1 and Year 2) and their growth rates are used to calculate a PER and a PEG. These are then used to identify a (fair value) Parity PEG Price for each year, as such…
For Year 1 the Current Price and the forecast EPS for Year 1 are used to calculate the PER for that year (Current Price/Year 1 EPS Forecast). The Annual EPS Growth Rate is calculated by comparing the most recently reported EPS with the Year 1 EPS Forecast. This is then compared with the PER to come up with a multiple based on a PEG of 1. So, if the growth rate is 30% and the PER is 15 the multiple would be 2. The Current Price is multiplied by that difference to come up with a (fair value) 1 Year Parity PEG Price.
For Year 2 a similar approach is adopted. This time the starting price is the newly calculated 1 Year Parity PEG Price from above. The assumption here is that at the end of Year 1 the price will reflect a PEG of 1. The same formula is applied again for Year 2 (only this time using and comparing the Year 1 EPS Forecast with the Year 2 EPS Forecast) to come up with a (fair value) 2 Year Parity PEG Price.
Here’s An Example
Summary
This is of course quite a simple and straight forward approach. Some will agree with it, others will disagree with it. It doesn’t really matter, it makes sense to me and it is useful to me in my investment process. The majority of my Buy/Sell decision making is based on this analysis.
There are two major assumptions to point out (I am willing to add to this list in the future) here…
The first is that price, in both 1 and 2 years time, will reflect a fair value, meaning the PER will be in-line with the Annual EPS Growth Rate (the PEG will be equal 1).
The other is that the Stockpedia or, in most cases, the Broker forecasts are accurate (at least to a reasonable degree).
I hope there is enough detail above for now. I will try and find time to expand on this guide in the weeks ahead.
Monthly Parity PEG Price Reports…
Each month I analyse at least 20 stocks in a Monthly Parity PEG Price Report. The report usually includes coverage of any stocks I have traded (bought or sold) that month.
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