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The YPEG Explained

One of the tenets of Foolish stock picking is to establish a fair value for any stock based on fundamental criteria---primarily earnings growth. But the Fools note in The Motley Fool Investment Primer that the Fool Ratio (or PEG---P/E ratio divided by the estimated Growth rate) is really best used for small-cap growth stocks, not as a tool for all kinds of stocks.

What, then, can we use as an alternative if we're trying to put a fair price on larger companies? The larger the company and the more information that is known about it, the further into the future "the Street" generally looks to value a stock. So, one alternative to the more immediate Fool Ratio is a variation Tom Gardner calls the YPEG (the year-forward PEG).

The YPEG simply pushes the valuation approach further into the future. It's actually quite a bit easier to calculate than the traditional PEG, too, which makes it much more appealing for those of us who dread the thought of fractional roots. To get the YPEG price target for a stock, you need two numbers: next year's estimates earnings and the projected five-year growth rate for the stock.

Both of these numbers are available on our AOL site for many companies from FirstCall in the Company Research area (Keyword:Earnings). Let's look at an example:

According to FirstCall's December 11, 1995 update, the consensus earnings estimate for Gateway 2000 (NASDAQ:GATE) in 1996 is $2.71 per share. The consensus five-year estimate growth rate is 20%. To get the YPEG price target, simply multiple the two numbers together (2.71 X 20 = 54.20).

That gives us a price target over the next year of $54 for Gateway 2000. Since Gateway currently trades at approximately $27, it's exactly 100% under-valued based on future earnings estimates.

Keep in mind that the YPEG is not the only tool you should be using to help you make investment decisions, but it can provide a rough price target for stocks you're considering. Apply a few other fundamental tests as well and you'll be in a reasonably Foolish position when it comes time to make a decision.

Robert Sheard (MF DowMan)


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