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Growth at a reasonable price, is a valuation and analysis framework which works best when applied to growth stocks: companies where the share price might be a chunky multiple of expected earnings per share, but where those earnings are still expected to grow at a decent annualised rate going forward. Shifting the emphasis to valuing the earnings growth rate, rather than merely static estimates of profits at various points in the future is the premise which underpins the price-to-earnings growth or ‘PEG’ ratio.
The trouble with PEG ratios is they can make stocks on a cyclical upswing look very cheap and attractive when they actually warrant the extra risk premium that’s reflected in their modest pricing. In such cases, it could be the share price is too close to a cyclical peak and at risk of a reversal. For this reason, we also use a variation of the PEG method that blends historic and forward growth rates and the dividend yield, to give a smoothed out valuation ratio.
