In a recent article I covered the use of the PEG ratio when evaluating prospective investments. Briefly the PEG (price earnings growth) ratio indicates the discount or premium being paid for estimated future growth. A reading of 1 indicates a fair price is being paid; below 1 indicates value may exist, above 1 may indicate that an excessive premium is being asked.
As mentioned the PEG ratio is just an indicator and deeper research should always be undertaken before reaching any conclusion. Nonetheless it's a very useful way of initially sorting the wheat from the chaff.
The PEG ratio is found by dividing the current price earnings ratio by the estimated growth rate. For example price earnings 15; estimated growth rate 9%; therefore PEG ratio = 15 ÷ 9 = 1.67.
Using this measure and given the remarkable popularity of the major banks and Telstra, is there any value in these stocks? To be objective I've used forward estimates from Bloomberg and analyst reports.
Comments below highlight factors from the recent reporting season likely to influence the forward earnings of these stocks.
Australia and New Zealand Banking Group (ASX: ANZ) had a predictable report, especially on domestic performance. However one concern is the indirect exposure to the Chinese Yuan carry trade which has been a red hot area over the past year. Basically this carry trade is based on the assumption that the yuan will appreciate against the US$ – instead, it has depreciated. With ANZ being a significant player in trade finance, margins from this activity are likely to contract – with a measurable effect on earnings growth. Assuming 6.5% growth in net 2015 earnings ANZ's PEG ratio is 2.17.
Commonwealth Bank of Australia (ASX: CBA). Latest results were positively enhanced by trading income and foreign exchange translation. There is also a need to build capital – forget special dividends. Margins on mortgage lending are coming under pressure. Assuming 4% growth in earnings over 2015, CBA's PEG ratio is a high 3.7.
National Australia Bank Ltd (ASX: NAB) is well advanced with repairing the balance sheet and is now in a relatively good capital position. NAB has been quiet on the domestic front as structural issues are being worked out. Assuming 7% growth in 2015 earnings per share, NAB's PEG ratio is 2.17.
Westpac Banking Corp (ASX: WBC) has flagged an intention to gear up the wealth management division which will result in an increase in return on equity. Domestic performance is good. Assuming 7% growth in 2015 earnings per share, Westpac's PEG ratio is 2.23.
Using the PEG indicator ANZ & NAB dead heat for first, followed by Westpac with CBA trailing well behind – however none of them appeal on a value basis. By way of comparison the US bank Wells Fargo has a current PEG ratio of 1.06 (Bloomberg).
In its recent report Telstra Corporation Ltd (ASX: TLS) indicated a significant shift is underway from high margin segments such as PSTN and Data to low margin NAS segments (network-attached storage). Mobile was a bright spot; however increased competition can be expected in this segment over the medium term. As a result, barring a game changer, Telstra remains a low growth stock and revenue may struggle to keep pace with inflation. Using a 2% growth rate in net earnings for 2015 the PEG ratio is an alarming 8.05.
Foolish takeaway
Just to repeat – the PEG ratio is no substitute for detailed research – however I've found it very useful as an initial indicator when comparing companies with fairly reliable earnings streams. With the above companies new buyers should be aware of the premium being paid for unrealised future growth.
