Forum Archive Index - March 2001

["Wedde, John" <john.wedde@cit.ac.nz>]

"Peg ratio" is pe ratio divided by annual earnings growth
I think this ratio was first discussed by Gordon Slater in his book "The
Zulu Principle. Making Extraordinary  Profits From Ordinary Shares". Slater
suggested it was useful for identifying growth companies at an early stage.
Gerry --- you should add this book to your bibliography -- easy to read and
some wonderful tips for successful investment.
Cheers,
John

-----Original Message-----
From: secondstep70 [mailto:secondstep70@hotmail.com]
Sent: Friday, 2 March 2001 09:47
To: sharechat@sharechat.co.nz
Subject: Re: [sharechat] Growth stocks - esp Baycorp


A measurement for value of a 'growth' company is the PEG ratio. (sorry I
can't tell you how it is calculated)
 
Yahoo finance gives Baycorp a PEG ratio of 1.61.
 
A rule of thumb is <1 indicates good value and >1 indicates poor value.
 
http://biz.yahoo.com/z/a/b/bch.nz.html
<http://biz.yahoo.com/z/a/b/bch.nz.html> 
 
Assuming the forecasts are accurate, Baycorp would have to see it's P/E
drop before it could be seen as a cheap buy.
 
 
 

----- Original Message ----- 
From: Peter  <mailto:pmaiden@xtra.co.nz> Maiden 
To: sharechat@sharechat.co.nz <mailto:sharechat@sharechat.co.nz>  
Sent: Thursday, March 01, 2001 7:39 PM
Subject: [sharechat] Growth stocks - esp Baycorp


Some talk about investing in growth stocks etc earlier today. Maybe these
thoughts may be interesting.

Firstly a disclosure - this has been extracted from a note I wrote a few
months ago to somebody who was worried about what to do with an investment
in Baycorp he controlled. I don't have any Baycorp shares myself but thought
that readers of this forum might appreciate my thoughts. Note that when I
wrote this the price was $12.50 odd - I see that it is down below $11.00
today.

Some research I came across a while ago showed that there is no correlation
between a company's expected long term earnngs growth (as per the company's
share price earnings ratio) and the long term price change in the company's
share. The study was conducted on the FTSE 100 over a ten year period in the
nineties and concluded that the correlation between PE ratios and subsequent
share performance is zero - stocks with low PEs do no better or worse than
stocks with high PEs. In other words PEs are useless as an indicator of
future earnings growth.

Isn't it a fallacy then to believe that to make money from shares you must
invest where the growth is. High earnings growth does not necessary mean
high long-term investment returns. 

However one shouldn't ignore earnings growth as over extended periods of
time a company's share price cannot grow faster than earnings. At least in
theory because if it did the PE and market capitalisation would approach
infinity. 

What the study did show was that the market does a poor job of forecasting
long term earnings.

To put a Baycorp slant on this.

Baycorp has a sensational business model and a proven record of strong
earnings growth. The business model appears to be able to sustain strong
earnings growth well into the future.

Thinking it through anything that is anticipated should not affect stock
prices. Is Baycorp meeting anticipated earnings growth? In spite of
achieving consistently high earnings over many years ( a no mean feat for a
New Zealand company) it does appear that Baycorp are not meeting anticipated
returns..

In 1997 EPS increased by 28%, in 1998 by 23%, in 1999 by 21%, in 2000 by12%
and in 2001 a projected 14%. Reported 20% plus increases in actual earnings
have been diluted by the issue of shares to fund growth.

The growth in EPS is slowing down - and the numbers do not support a PE of
50.

Over time there has to be to be an adjustment to the Baycorp share price to
a lower PE which better reflects actual EPS growth. This has dire
consequence on the Baycorp share price.

One way of looking at it is to assume that the share price remains at
$12.00. Even if 20% EPS growth is maintained into the future it will take
into 2006 for the $12.00 to reflect a PE of just over 20. At 15% EPS growth
it will take until 2008 before the price reflects a PE of 20.

The other way of looking at it is to assess what the current price should be
based on a different PE multiple. This year the EPS projection is 22.5 cents
(with total earnings up 20% on last year). A PE of 20 then gives a share
price of $4.56. The share price would then increase at the growth in
earnings rate if a PE of 20 was maintained. 

I have used a PE of 20 because that is the growth rate I have used in
calculations. Some might say that Baycorp should trade at a premium to this.
However it is the dimensions of the variance to the current price I am
trying to demonstrate,

Whatever happens this is one company that will continue to experience strong
earnings growth but it is very unlikely that investors will benefit from
long term gains in Baycorp's share price. Even a possibility of a takeover
is unlikely because of the inherent amount of goodwill that any acquirer
would need to take on - a market cap of $1B for a company with $70M revenues
and $20M earnings does not make a takeover likely.

And so on......to a recommendation

Cheers 

Peter

 

 

 


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