About a week ago you wrote that you uses a P/E ratio technique, which includes “colouring in” to accommodate other factors (that “qualitative stuff”). I imagine that in effect this is what most investors do with varying levels of skill. I think the current average P/E Ratio for the ASX is something like 14.3, so if you selected about ten companies that you know with P/E Ratios between 11 and 18, and slotted CCP into its appropriate spot by asking yourself if you prefer it to any on your list, you should come up with a P/E Ratio for CCP that is close to the one that you derived via “colouring in”. If you apply a margin of safety to that, you should come close to your buy-in price.
Both PEG and PEGY “colour in” mechanically to recognise growth, while their arithmetic limits the impact of the growth selected because growth rates tends to decay. PEGY colours in to recognise dividend payments too. Neither of them colour in for anything else. If one had an uncanny knack of estimating the many relevant impacts in future, including how one's IRR may be varied, then the logical valuation approach would be based on a very complicated DCF formula. Without that “uncanny knack”, a complicated DCF valuation technique would be like my hog-weighing technique, an indulgence in sophistry.
When Peter Lynch devised the PEG ratio ((Price/Earnings/Growth), he intended it as a rule of thumb for trawling for investment candidates that did not pay dividends. He modified PEG for dividend-paying stocks. That modified PEG is usually referred to as PEGY ((Price/Earnings/(Growth +Yield), which is more apt for CCP than the PEG ratio. If one applies PEGY to a non-dividend paying stock, one would derive the same numerical ratio that using PEG would derive, so if one automates the trawling algorithm, it makes more sense to base it on PEGY than having two formulae – one for dividend payers, and one for non-dividend payers.
Both PEG and PEGY miss significant factors that Lynch would have expected investors to consider as Step 2 when processing the trawled candidates – e.g, debt levels, macro and micro risks, management quality, the no-risk rate of interest, the investors IRR, et cetera – what you called “colouring in”. Lynch tended to use PEG and PEG ratios based on trailing data, leaving considerations of the future to Step 2 with the other “soft” considerations.
On truncating the growth effect, which my earlier underlined words imply are what the arithmetic of PEG and PEGY do, if Treasury offered a peculiar bond that paid $5 at the end of Year 1 that grew by 10% per annum, with an option to exit at will, but without getting anything back, one can be sure that the bond would be valued well above what a PEG ratio of 1 would suggest (namely, $50), or what a PEGY ratio of 1 would suggest (namely about $80), because the requirement to truncate the growth effect is absent. An investor with a high IRR of 15% would pay be inclined to pay $100 for this special bond, and lower IRRs would elicit much higher prices.
I think we have done this PEG-and-PEGY matter to death, and the topic is anyhow more a generic one than a CCP-specific one. At least now when somebody mentions PEG, I'll have more understanding of the issues than I had a few days ago.
CCP Price at posting:
$12.12 Sentiment: Hold Disclosure: Held
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