How to Value Stocks: The Fool Ratio

Introduction: The Fool Ratio

How to Value Stocks

The Fool Ratio, developed by the Editors of The Motley Fool Online a few years back, is a pleasingly simple bit of mathematics that, since its inception, has winningly valued small- and mid-cap growth stocks in most industries.

The premise upon which this Foolish stratagem is based is rather simple. It's an investment valuation rule of thumb, actually:

In a fully and fairly valued situation, a growth stock's price-to-earnings ratio should equal the percentage of the growth rate of its company's earnings per share.

Taking that as a given (and it is, to flirt with an oxymoron, accepted Wall Street wisdom), the Fool Ratio neatly and numerically summarizes a stock's P/E ratio in relation to its company's growth rate.

Now, if you're a total novice, the last paragraph may have read mostly like gibberish to you. Don't sweat it. We're dealing with simple mathematical concepts here. It's mainly the investment jargon and Foolish philosophy that need explaining, which is what this article is all about. For your convenience we have included a PEG & YPEG Calculator.

So let's proceed pace by pace toward an understanding of the Fool Ratio. The key concepts are explained bit-by bit in the listbox above. Remember, the PEG is only ONE indicator of a stock's potential value. Before buying any stock, make sure to comb through the company's financials. And keep in mind, those Foolish enough to pursue our full approach may wish to poke their heads into FoolMart to procure a copy of The Motley Fool Investment Guide. Written to inform the novice and amuse the sophisticate, the Guide provides a more thorough analysis of our Foolish investing approach with clear, colorful examples to guide you through.

PEG on!

Next: The P/E Ratio »