Understanding a Stock's PEG Ratio

By Chris Perruna

A PEG ratio cannot be used alone but is a very powerful tool when integrated with the basics (price, volume and chart reading). You must enjoy crunching numbers and have a calculator handy to estimate your own PEG ratio. Access to quality statistical information from the web such as past earnings and future earning estimates is essential to calculate this fundamental indicator. A variety of websites produce a PEG ratio but I have not found one site that has a reliable PEG ratio that I can use for my own research, so I calculate it myself, ensuring accuracy with the final number.

I am going to use the definition from investopedia.com as it makes complete sense and doesn’t get too confusing (below the definition is further explanation and a current real time example, using Apple Computer).:

The PEG Ratio:
“The PEG ratio compares a stock's price/earnings ("P/E") ratio to its expected EPS growth rate. If the PEG ratio is equal to one, it means that the market is pricing the stock to fully reflect the stock's EPS growth. This is "normal" in theory because, in a rational and efficient market, the P/E is supposed to reflect a stock's future earnings growth.

If the PEG ratio is greater than one, it indicates that the stock is possibly overvalued or that the market expects future EPS growth to be greater than what is currently in the Street consensus number. Growth stocks typically have a PEG ratio greater than one because investors are willing to pay more for a stock that is expected to grow rapidly (otherwise known as "growth at any price"). It could also be that the earnings forecasts have been lowered while the stock price remains relatively stable for other reasons.

If the PEG ratio is less than one, it is a sign of a possibly undervalued stock or that the market does not expect the company to achieve the earnings growth that is reflected in the Street estimates. Value stocks usually have a PEG ratio less than one because the stock's earnings expectations have risen and the market has not yet recognized the growth potential. On the other hand, it could also indicate that earnings expectations have fallen faster than the Street could issue new forecasts.”
- provided by www.Investopedia.com

PEG Ratio Example:
Using Apple Computer Inc., I will demonstrate how to calculate the PEG ratio without relying on other websites.

First, you will need to gather the past earnings numbers; going back at least 2 years and going forward two years. (All data is from Thursday, June 23, 2005)

AAPL:

2003: 0.09

2004: 0.36

2005: 1.31 (E)

2006: 1.52 (E)

Now we need to calculate the growth from year to year.

Subtract the earnings of 2004 by 2003 and then divide by 2003.

Repeat the process to determine the growth rate for the following years:

2004: (0.36-0.09)/0.09 x 100 = 300% growth rate

2005: (1.31-0.36)/0.36 x 100 = 264% growth rate

2006: (1.52-1.31)/1.31 x 100 = 16% growth rate

Now, take the current price (we will use the close from Thursday, June 23, 2005: $38.89) and divide it by 2004 earnings and then by the 2004 growth rate:

2004: 38.89/ 0.36 / 300 = .36 PEG Ratio

2005: 38.89/ 1.31 / 264 = .11 PEG Ratio

2006: 38.89/ 1.52 / 16 = 1.59 PEG Ratio

Using the definition from above, Investopedia states that a stock is evenly valued at a PEG ratio of 1 in a rational and efficient market. Please note that the stock market is not very rational or efficient so we only use this number as a secondary indicator and tool, after our fundamental and technical analysis is complete. Apple’s PEG Ratio of 0.11 for 2005 was discounted into the price when these estimates first hit the street, giving us the big run-up late last year. Going forward, the stock’s earning potential looks to slow considerably and the PEG ratio clearly shows us the tremendous jump in numbers from 2005 to 2006. A PEG ratio of 1.59 for 2006 is not the best rating going forward but still under the red flag ratio of 2.00.

Finally, once you determine the PEG ratio of the stock you are looking to buy, take the time to calculate the PEG ratio for the “sister stocks” in the industry group to see if they have higher or lower PEG ratios. Keep in mind, PEG ratios don’t work for companies with negative or non-existent earnings numbers.

Chris Perruna - http://www.marketstockwatch.com

Chris is the founder and president of MarketStockWatch.com, an internet community that teaches you how to invest your money with solid rules. We don't stop at just showing you our daily and weekly screens, we teach you how to make you own screens through education. Through our philosophy, you will be able to create your own methods and styles to become successful.

Article Source: http://EzineArticles.com/?expert=Chris_Perruna

Trade Stocks for Real

By Chris Perruna

I read a comment by a forum member on another site earlier today that suggested that every investor should back test their system for at least twenty years. I disagree and will now tell you why. Back testing and paper trading seem to be the most over emphasized techniques offered by market theorists, educational elite, market novices and/or market fakes. While learning the pure basics, I can see why a novice investor may want to paper trade; to see the results of the developing system but I will warn that these results are completely false. The results will not contain the emotional decisions that go along with risking your own cash. Anyone and I mean anyone can paper trade successfully. It’s simple, place a trade and hope it goes up and if it doesn’t, you have no worries because you can’t lose. The emotional imbalance that occurs when you really start to lose money is not present. Don’t fool yourself by believing the results of your paper trading or virtual simulation portfolio. These things may give you some confidence in your system but they don’t prove a damn thing in the real world. The real world, specifically the stock market, is run by emotional human beings. People make decisions that are irrational and base their trading decisions on fear and greed. Paper trading lacks fear and greed because there is no gain and no loss; therefore there is no consequence to deal with.

Don’t worry about back testing for 20 years because historical back testing is never very accurate. The most accurate testing is real time. If you can back test real trades (actual trades that you have made in the past), then this would be just as good as real time testing (or forward testing). Back testing can get you somewhat of an idea of how your system will perform but there is no emotional attachments to this type of testing so it is not realistically accurate. We all know emotions are tied to our decisions in the markets so we can only get accurate results through real testing. Learn to ignore the talking heads and the people on TV and that internet chat room that claim they are up over 1000% trading a fake account. What really makes me laugh is the person that sets up a virtual trading scenario and then allows each participant to trade $500,000 or more in their account. If you are going to trade a fake account, at least keep it real so you try to learn something, maybe money management.

I setup one virtual trading competition a few years back and I only allowed each participant to start with $10,000, a reasonable amount, an amount that most people start trading with. The competition was fun but it was not real for me or the others. I didn’t care what risks I took and I never had a problem pulling the trigger which does happen in real life. I did try to keep my trades in line with my real life account but it varied slightly. I witnessed other traders making 20 trades per day or 20-50 trades per week. This is not real because the commissions alone, even with a discount broker will wipe you out. I did allow margin because I use margin in my account but I saw other investors abusing the fake power of margin in their virtual account, again, playing the game for fun instead of learning something valuable. As a fellow investor, keep testing your system in real time and you will know what works and what doesn’t based on real trades, not simulations. Professors and the like teach theories while investors actually do the trading! Back testing may convince some people but I am only convinced with what works now, in real time. Besides, why would I waste my time playing for fake money when I can learn and do for real? Back testing may be good for some people but I have been testing my systems in real time since the day I started investing seriously. Currently, I am testing the $60-$100 theory using options in my newest account. I will not have concrete data on this system for another year or two, most likely two years down the road. I could back test the system but how will that help me realistically going forward? It won’t, it may show me some probabilities and the possible expectancy of the system but it won’t guarantee anything until I place a position for real.

If you want to test a system, open an account with real money, even a minimal amount and give it a try. Make sure you use enough money to allow emotions to be attached to your decisions. Without the emotional attachment, you are cheating yourself and your potential system.

Chris Perruna - http://www.marketstockwatch.com

Chris is the founder and president of MarketStockWatch.com, an internet community that teaches you how to invest your money with solid rules. We don't stop at just showing you our daily and weekly screens, we teach you how to make you own screens through education. Through our philosophy, you will be able to create your own methods and styles to become successful.

Article Source: http://EzineArticles.com/?expert=Chris_Perruna

Stock Trading Types -- Which Type Are You?

Stock Trading Types -- Which Type Are You?
By Matt Fox

If you want to be stock market player you need to learn some fundamentals. There are different types of stock market players. You could be a day trader and jump in and out of stocks every day trying to pick up enough small gains on big share holdings. I think of this like betting huge amounts on the favorite in a horse race to show or come in third. This is gambling to me. We would call these types of players “jumpers” because if they lost a huge bet they might just jump out the window of a tall building. Most day traders get broke in short order. Leave that to the professionals who don’t do so well at it either.

There are the speculative traders who will hold a stock for short time periods of a few days to a few months. If done properly this can be the best type of trader to be. Then there are the buy and hold investors. Warren Buffet was the most successful buy and hold investor in history. He was and still is a “buy and die” investor. In the past when commission fees were sky high and it was costly to trade stocks in this manner this was an excellent strategy. Now the fees are very reasonable so the strategy has changed to be more speculative.

These types of traders can be broken down farther into two main groups, the technicians and the fundamentalists. A pure technician will rely on his charts exclusively and look for patterns over history and use the patterns of many stocks to form his strategy. The pure fundamentalist is going to rely on the income statement, balance sheet and other financial documents of a company to decide if the business is strong enough for him to put his money into its shares. Most traders use a hybrid of both types, the technician and the fundamentalist. I am a hybrid type of trader and look at the macro view of the economy as well. I like to look into the future of the economy about six months ahead of the present day as much as the past data that was recently released.

With three startup businesses before he was 21 years old, Matt Fox has the experience to help you create your own businesses for your financial future. He is a wealth building and investment specialist. See his blog at http://www.bizmaker.blogspot.com

Article Source: http://EzineArticles.com/?expert=Matt_Fox