Is it true that when you calculate PEG, you use % of g*100? In other words, if growth is 4% and P/E is 16, to find the PEG you take 16/4, not 16/.04? Because I am tempted to want to convert 4% into .04, but dividing by .04 would give me a PEG 100 times larger…
Correct the G in PEG is a %age number not a decimal converted fraction.
CFAI Mock 2012 Morning, answer to question 59 : PEG assumes a linear relationship between P/E and growth
Schweser Notes 2012, Book 3, page 205: The relationship between P/E and g is not linear , which makes comparisons difficult.
Who is right ??
To see that for yourself, plot various values of g along the X-axis, say g from 1 to 100, and on the y-axis plot PEG, using a fixed P/E of 10. Look at the line. Is it linear? Not at all.
On second thought, I’m not sure if the above is the correct way of looking at it.
What is clear to me is that PEG=PE/G. If PE goes up by 100% and G goes up by 100%, PEG is the same. If PE goes up by any percentage nd G goes up by same percentage, PEG is the same. Based on that, I would say that PEG is a linear function of PE and G. Still not 100% sure, though.
CFA book is correct in saying that PEG assumes linear relation between PE and G. The basis for this assumption is that PEG is used to formalize the PE ratios and associate it with the growth rate of the company. So if a company is growing by 200% or twice, then its PE should also be doubled to meaningfully reflect the growth in the valuation. PEG is not very accurate and is used for short term as it takes only 1 year growth into consideration.
Whether the linear relation is really correct or not is a different story, realistically double growth does not mean double value for the company as not all the growth adds value, so in reality the linear relationship may not hold, but for theorotical and basic screening purpose it is assumed to be linear
CFA book is correct in saying that PEG assumes linear relation between PE and G. The basis for this assumption is that PEG is used to formalize the PE ratios and associate it with the growth rate of the company. So if a company is growing by 200% or twice, then its PE should also be doubled to meaningfully reflect the growth in the valuation. PEG is not very accurate and is used for short term as it takes only 1 year growth into consideration.
Whether the linear relation is really correct or not is a different story, realistically double growth does not mean double value for the company as not all the growth adds value, so in reality the linear relationship may not hold, but for theorotical and basic screening purpose it is assumed to be linear