How to use the PEG ratio to evaluate companies

It is that time of the year when annual reports start arriving in mailboxes. With the stock market at a new high, it is becoming increasingly difficult to find stocks available at reasonable valuations.

All the more reason to take some time in going through annual reports in detail to find out which stocks to hold, which stocks to sell and which stocks to add more of.

The Price-to-earnings ratio (i.e. CMP/EPS) is commonly used to evaluate whether a company is fairly priced or over/under-valued. What the ratio doesn't reflect is whether earnings are growing or not.

The Price-to-earnings growth ratio (PEG = PE ratio/Annual EPS growth %) can provide a more realistic valuation metric.

Let us look at the ratios of two FMCG companies - HUL (MNC) and Marico (Indian):

HUL - EPS for FY17: 20.75; for FY16: 19.12; EPS Growth: 8.5%; P/E: 52.8;
Therefore, PEG = 52.8/8.5 = 6.2

Marico -  EPS for FY17: 6.53;  for FY16: 5.36; EPS Growth: 21.8%; P/E: 48.6;   
Therefore, PEG = 48.6/21.8 = 2.2

The P/E ratios of both companies seem high. But Marico's PEG is much lower, making it a better value than HUL (at Jun 1 '17 closing prices).

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