Question: The table below has information on the
trailing PE ratio, the forward PE ratio, and the PEG ratio for four firms. Two of the firms AAPL and AMZN are considered
growth firms. Two of the firms GS and
NEE are value firms.
Financial Ratios for Four Firms


Trailing PE

Forward PE

PEG


APPL

20.05

16.31

1.46

AMZN

154.59

76.94

2.46

GS

18.68

9.21

0.3

NEE

9.96

20.56

2.37

Show how these three
financial ratios can be used to measure expected earnings growth?
Discussion:
These financial statistics
can be used to create three measures of earnings growth.
Caution: The
growth measures only make sense when earnings is positive. The PE ratio is a nonsensical statistic when
earnings are negative. Also, when
earning are very close to 0 the PE ratio will be very large and earnings growth
estimate will be sensitive to small changes in earnings.
The first growth measure is based
on the ratio of trailing PE to forward PE.
This ratio simplifies to EF/ET where EF is forward earnings and ET
trailing earnings because the same stock price is in the numerator of both PE
ratios.
It follows that 100*((EF/ET) 1) is the projected
growth rate in earning because EF is projected earnings next year and ET is
earnings in the current year.
The second measure of
projected growth is the ratio of the trailing PE ratio to the PEG ratio. The third projected growth ratio is the ratio
of the forward PE ratio to the PEG ratio.
The PEG ratio is defined as
PE ratio divided by growth in earnings over some period. The ratio of PE to PE over growth in
earnings simplifies to growth in earnings.
I don’t know whether the
reported PEG ratios in yahoo finance, the source of my data, use trailing or
forward PE. Also, I don’t know the time
frame of the earnings growth used in the denominator of the PEG.
My approach is to present all
three measures of projected growth for the four firms.
Calculations:
Here are my calculations of the three
projected growth statistics for the four stocks.
Projected Growth Rate in Earnings


Trailing PE to Forward PE

Trailing PE to PEG

Forward PE to PEG


APPL

22.9

13.7

11.2

AMZN

100.9

62.8

31.3

GS

102.8

62.3

30.7

NEE

51.6

4.2

8.7

Observations on the growth projections
On all three measures AMZN
and GS are virtually tied as having the highest projected growth rates in
earnings. The rank orders of the
projected growth estimates for the four companies, while not identical, are
similar.
One company NEE (Nextera
Energy) has projected negative growth because the forward earnings estimate is
less than current earnings estimate.
The ratio of trailing to
forward PE ratios lead to the higher projected growth rate for three of the
four companies. The one exception is
NEE.
Concluding Remarks:
These projected growth statistics
can be used to measure expectations in the market. Large projected growth in
earnings could indicate that analysts are excessively optimistic. This currently appears to be the case for
several highlytraded tech firms.
Go to my finance blog for an
example looking at these ratios for a comparison between PE ratios from a growth ETF and a value ETF. The results are somewhat surprising. Most analysts are concerned about the valuation of tech stocks but the negative PE ratio of a significant number of value firms appears to be a larger concern.
https://financememos.com/2018/09/12/valuationofgrowthandvaluestockswithperatios/
https://financememos.com/2018/09/12/valuationofgrowthandvaluestockswithperatios/
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