PEG Ratio Calculations
Reliance Steel & Aluminum (
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A sure-fire method to find stocks that will outperform the stock
market during the next year or two is to ferret out high-quality
stocks with low PEG (Price Earnings Growth) ratios. Many of you
know how to calculate PEG ratios, but you may not know that many
professional analysts calculate the ratio differently depending
on their objectives.
Here are three methods to calculate this important ratio.
Determine the PEG ratio by dividing the price to earnings (P/E)
ratio by the earnings growth rate. The price in the P/E ratio is
the stock's recent stock price-I used the July 25, 2012 closing
price in today's calculations. Earnings consist of estimated
earnings per share (
) for the next 12 months. The growth rate (the "G" in the PEG
ratio) is the estimated rate of EPS growth for the next five
years. A PEG ratio of less than 1.00 indicates that a stock is
undervalued. The lowest PEG ratios are best. This method is best
applied to growth stocks with high short-term and long-term
Rather than using estimated EPS, the last actual 12-month EPS are
used. The P/E ratio is therefore calculated by taking the current
price and dividing by the last four quarters of EPS, also
referred to as current EPS. The P/E is then divided by the
forecast five-year EPS growth rate, the same growth rate as used
in the first method. This PEG method is more conservative and is
best applied to value stocks with low P/E ratios.
The Third Method
brings the dividend yield into play. The P/E ratio is calculated
as in the Second Method using last 12-month EPS. Then add the
dividend yield (annual dividend per share divided by current
price) to the five-year EPS growth rate. Divide the P/E ratio by
the sum of the growth plus yield. This is a good method for
comparing companies paying higher than average dividends.
Lastly, look for good quality companies with a history of steady
earnings and dividends growth. Quality companies may not be
extreme bargains, but high-quality companies will likely produce
reliable dividend income and price appreciation.
You can use a very simple measure to determine which companies
are high quality and have produced steady earnings and dividend
performance during the past five to 10 years. Standard &
Poor's evaluates most stocks and assigns a ranking called the
S&P Quality Ranking.
Companies with A+, A, and A- S&P rankings indicate
high-quality. I generally like to find companies with these
rankings, although I will often include a company with a B+
ranking or occasionally a B ranking, if I believe the company has
exceptional prospects. S&P rankings are usually provided on
your broker's website. Just go to the stock research tab and
enter S&P in the search box.
For more than seven years, I have recommended companies with high
S&P Rankings and low PEG ratios every six months in the Cabot
Benjamin Graham Value Letter. My recommendations have more than
doubled Standard & Poor's 500 Index during the same
seven-year period through July 25, 2012.
And high-quality stocks with low PEG ratios have consistently
outperformed the stock market indexes in both advancing and
declining markets. Investing in quality stocks at bargain prices
makes sense in any stock market environment.
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Two good examples of high-quality companies with low PEG ratios
Reliance Steel & Aluminum (
. The companies have S&P Quality Rankings of A- or better and
their PEG ratios are less than 1.00, using the Third Method
Standard & Poor's Quality Ranking for Aflac is A-, which
indicates the company has produced steady earnings and dividend
performance during the past five to 10 years. My calculation of
Aflac's PEG ratio of 0.59 is based upon a stock price of 41.29,
current earnings per share of 5.02, my estimated five-year
earnings per share growth rate of 10.8%, and the current dividend
yield of 3.2%.
Standard & Poor's Quality Ranking for Reliance Steel is also
A-. My calculation of RS's PEG ratio of 0.72 is based upon a
stock price of 44.98, current earnings per share of 5.02, my
estimated five-year earnings per share growth rate of 10.3%, and
the current dividend yield of 2.2%.
Aflac, Inc. (
is the world's largest supplemental cancer insurance provider,
deriving 75% of its business from Japan. Most of Aflac's policies
are individually underwritten and marketed at worksites through
independent agents, with premiums paid by the employee.
Aflac Japan's insurance products are designed to help pay for
costs that are not reimbursed under Japan's national health
insurance system, and include supplemental health and life
insurance. Aflac Japan provides insurance to one out of every
four Japanese households and the company's policy-renewal rate is
Aflac has expanded its product line and added new marketing
venues in recent years. Non-cancer insurance policies now account
for 70% of new sales. Rapid growth in Japan is propelled by
success in selling through banks and post offices. Sales reps are
located at many banks and post offices throughout Japan to sell
Aflac products to customers.
U.S. sales are lagging, but the company's focus on new products
and its successful promotions in Japan are producing strong
performance. Sales increased 13% and EPS jumped 40% to $5.02
during the four quarters ended June 30, 2012. The increases were
propelled by better than expected sales from bank and post office
locations, and by lower investment portfolio losses.
I forecast sales and earnings per share growth of 9% and 17%,
respectively, during the next 12 months. Growth could receive an
additional boost if lackluster U.S. sales improve noticeably and
investment losses diminish to zero.
AFL shares sell at just 8.2 times current EPS. New products and
further successes in Japan will produce strong growth in future
years. AFL sells at a low price because investment losses have
hurt earnings during the past four years. Most of the investment
risk has been removed from Aflac's investment portfolio now,
however. With a low modified PEG ratio of 0.59 and a dividend
yield of 3.2%, AFL shares are a bargain. The company has raised
its dividend for 29 consecutive years. Buy Aflac now.
Reliance Steel & Aluminum (RS
) is one of the largest metals distributors in the U.S. The
company's service centers provide specialized metals processing
services and distribute more than 100,000 metal products, made
primarily from steel and aluminum.
Reliance buys large quantities of raw metals from primary metals
producers. The company then sells smaller quantities to clients
after cutting and shaping the metals, and performing other
services. Reliance sells to a diverse customer base in the
machinery, aerospace, oil drilling, mining, farm equipment, and
construction industries, and to customers in many other
Reliance has achieved great success by acquiring smaller
competitors at bargain prices during the past decade. Sales
increased 20% and earnings climbed 35% during the past four
quarters ended June 30, 2012. Results were aided by stable
pricing and strong demand from customers in the oil and gas,
aerospace, and farm and heavy equipment industries. Management
expects demand to continue to be strong during the next several
I expect sales to rise 9% and EPS to advance another 15% during
the next 12 months. Reliance's strong balance sheet will enable
the company to continue to acquire competitors. The company has
acquired several companies thus far in 2012, which bodes well for
RS shares sell at 9.0 times current EPS with a dividend yield of
2.2%. The quarterly dividend was increased from 0.15 to 0.25 on
July 26. The company's stock price tends to be volatile, as a
result of erratic quarterly earnings, but I believe the current
low price and low PEG ratio of 0.72 presents an excellent buying
opportunity. Buy RS now.
Until next time, be kind and friendly to everyone you meet.
J. Royden Ward
Cabot Benjamin Graham Value Letter
Editor's Note: You can read more about PEG Ratio analysis and
Benjamin Graham and get continuing coverage of Aflac and Reliance
Steel in the
Cabot Benjamin Graham Value Letter.
There you'll not only find buy and sell advice for Aflac and
Reliance Steel, you'll get 20 other excellent value stock
recommendations from J. Royden Ward each and every month. Roy
applies the strategy of the father of value investing, Benjamin
Graham, to find the market's best undervalued stocks. And he will
tell you exactly when to sell. Seven of Roy's recent
recommendations have gained more than 25% in less than six months
using the PEG ratio system. Remarkable! Don't miss out on his
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