Reese: Looking at Lynch’s Famous “P/E/G” Ratio

John Reese, CEO and founder of Validea.com and Validea Capital, looks at the Peter Lynch “P/E/G”  ratio in this Globe & Mail Expert Podium column. The P/E/G was one of Lynch’s favorite valuation measures and it is calculated by dividing a stock’s P/E ratio by its growth rate. “The P/E/G tells you how much you’re paying to get a piece of a company’s growth, and Lynch found it to be a great way to identify growth stocks still selling at a good price, ” writes Reese.

Reese, who utilizes the Lynch strategy in his research and money management, notes that Lynch “applied the ratio slightly differently to different types of stocks. For larger companies with moderate or lower growth rates, he adjusted the “G” portion of the P/E/G equation for dividend yield, because one of the draws of such stocks is that they often pay high yields. For faster-growing firms (those growing at a 20% per year or greater clip), he didn’t factor in dividend yield, since they typically reward shareholders with growth in stock value, not dividends.”

In the article, Reese highlights a couple Canada-based stocks — Canadian National Railway (CNI) and Talisman Energy Inc. (TLM) — that both trade in the U.S. and have low P/E/G ratios and other solid fundamentals.