On Wall Street, the pursuit of value reigns supreme. Yet, a stock’s price alone sheds little light on its intrinsic worth. To truly discern a stock’s cheapness or expensiveness, factors like profits, sales, and shares outstanding must be considered alongside the share price.
Comparing stocks apples-to-apples necessitates delving into the relationship between share prices and fundamentals such as sales, earnings, or growth.
Measuring Value in Stocks
When gauging a stock’s value, there are myriad methods, but let’s zero in on the PEG ratio. This valuation measure scrutinizes three key values:
- stock price
- earnings-per-share
- expected earnings-per-share growth
The PEG ratio seeks to answer: How costly is a stock relative to its earnings growth? Essentially, akin to the price-to-earnings (P/E) ratio, the PEG ratio divides the P/E ratio by the stock’s projected earnings growth rate.
By factoring in expected earnings growth, the PEG ratio caters to investors’ inclination to pay a premium for profit-growing stocks.
Consequently, the higher the PEG ratio, the pricier the stock relative to its earnings growth rate.
Thirty years ago, a PEG ratio of 1.0 signified fair value, though this benchmark has shifted due to multiple factors. Presently, the average PEG ratio approximates 1.5, with significant discrepancies evident across sectors.
For instance, certain energy firms boast PEG ratios well below 1.0. Exxon Mobil presently holds a PEG ratio of 0.24. This trend extends to various other value stocks; for instance, Southern Co, a major utility enterprise, touts a PEG ratio of 0.44.
Conversely, swiftly-growing sectors typically feature markedly higher PEG ratios. Broadcom, for instance, exhibits a PEG ratio of 1.5; in contrast, Adobe commands a lofty PEG ratio of 8.6.
In essence, it’s advisable to juxtapose PEG ratios within sectors or at least among comparable entities.
Evaluating the “Magnificent Seven” Stocks
Drawing on the PEG ratio, let’s analyze the Magnificent Seven stocks.
Firstly, where does Tesla fit into the picture? Presently, Tesla’s eliminated from consideration for two reasons.
- Owing to erratic earnings outcomes and projections, Tesla’s current PEG ratio surpasses 70, deviating significantly from its average PEG ratio of around 2.5.
- Regarding its sector, as an auto manufacturer amidst tech-oriented peers within the Magnificent Seven, Tesla stands apart. Hence, for comparative purposes, Tesla is omitted.
So, what’s notable? To me, Apple, and to a lesser extent, Microsoft, stand out starkly.
Undoubtedly, this revelation may come as a surprise, but it aligns with my perspective on Apple. Simply put, Apple isn’t experiencing rapid growth, leading investors to pay elevated prices for stagnant or marginally growing earnings. Contrast this with Nvidia, witnessing exponential earnings growth; in the latest quarter ending July 28, 2024, Nvidia’s earnings surged by 168%, while Apple’s grew a mere 8%. In essence, Apple no longer embodies the growth dynamo it once was.
Turning to Microsoft, while its PEG ratio hovers nearer to the norm, relative to its counterparts, Microsoft is relatively pricey. This scenario likely positions the stock between fair value and overvaluation based on the PEG ratio gauge. While my stance on Microsoft remains optimistic, this valuation suggests it may be time to temper my bullish sentiment toward the stock.
