What would you prefer:
a) a company growing at 20% on a PE of 20
b) a company growing at 5% on a PE of 5
The PEG is 1 in both cases. If you were Peter Lynch, I suspect you would give “a” as your answer. If you were Anthony Bolton, you would give “b” as your answer “every day” (p 75 of Investing Against The Tide)
I thought it would be interesting to put this to the test in the context of the (Ben) Graham simplified pricing model:
V = E * (8.5 + 2 g)
where V is the implied value of the company, E is the EPS, and g is the growth rate, in percent.
Graham did elaborate on his model for adjust for corporate bond rates, but I’ll ignore that model.
Given a PE P for a company, the value to price R of a company will then be given by:
R = (8.5 + 2 g)/ P
So if g = 5%, and P is 5, then R = 3.7
If g = 20% and P is 20, then R = 2.4
In other words, Bolton’s conclusion agrees with Graham’s model. Which is quite interesting.
A heavy caveat needs to be applied, of course: Graham’s model is an empirical observation made decades ago, and is a pricing model rather than a intrinsic value model.