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PEGY ratio is calculated as PE ratio/(Earnings Growth Rate + Dividend Yield). Putting aside the discussion of whether forward or trailing P/E ratio should be used, isn't adding dividend yield over estimating the growth rate. After all common stock dividends are paid from net income.

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  • $\begingroup$ Cash paid as dividends will not be used to finance internal reinvestment, which drives earnings growth. Arguably G+Y represents the internal + external compounding of returns on equity. $\endgroup$ – experquisite Dec 3 '14 at 0:28
  • $\begingroup$ That said, we are adding unlike terms, so it doesn't make much sense. $\endgroup$ – experquisite Dec 3 '14 at 0:40
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This is all off the top of my head, but how about this:

$$ PEGY = \frac{PE}{EG+DY} $$ $$ PE = \frac{P}{E_n} $$ $$ EG_{forward} = \frac{E_{n+1} - E_n}{E_n}$$ $$ DY = \frac{D}{E_n}$$

$$PEGY = \frac{\frac{P}{E_n}}{\frac{E_{n+1} - E_n}{E_n} + \frac{D}{E_n}} = \frac{P}{E_n} \frac{E_n}{E_{n+1} - E_n + D} $$ $$PEGY = \frac{P}{\Delta E + D}$$

And examining the bottom term, one can easily imagine that a company whose annual delta-earnings is 100 with no dividends is not preferable to a company whose annual delta-earnings is 100 but which additionally pays a dividend of 50 every year. The dividends have been double-counted, but the second company didn't have access to that cash with which to compound growth. But I am not 100% sure where I am going with this.

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  • $\begingroup$ Thanks experquisite, but I still don't get it. P/E ratio tells how many years it would take to double your money. Assume $100 for a share with an annual earnings of $5. The P/E ratio suggests that in 20 years you would double your money, ignoring time value of money. Enter growth rate and PEGY. Since PE ratio does not account for growth rate, PEGY was introduced. If the company earnings in the above example grew at 20% the time required to double your money would be lesser. Dividends are going to reduce earnings 1 for 1. So it does not make sense to include dividends in the denominator. $\endgroup$ – Karthik Balasubramaniam Dec 4 '14 at 4:43

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