Legendary investor Peter Lynch wrote in his 1989 book One Up on Wall Street that the price-to-earning (P/E) ratio of any company that's fairly priced will equal its growth rate.
To calculate the PEG ratio, you divide the P/E ratio by the earnings growth rate. For example, if a company has a P/E ratio of 20 and an expected earnings growth rate of 10% per year, the PEG ratio would be 2.
Peter Lynch's statement implies that for a growth stock with an expected annual earnings growth of 20%, investors should ideally not pay more than a P/E ratio of 20.
This is a fairly conservative metric to apply. Let's take some examples of ASX growth shares using FY25 P/E ratios and their earnings-per-share (EPS) estimates for two years from FY24 by S&P Capital IQ:
- Pro Medicus Limited (ASX: PME) shares are trading at a P/E of 140x for a two-year EPS compound annual growth rate (CAGR) of 30%
- Lovisa Holdings Ltd (ASX: LOV) shares are trading at a P/E of 32x for a two-year EPS CAGR of 26%
- Netwealth Group Ltd (ASX: NWL) shares are trading at a P/E of 50x for a two-year EPS CAGR of 22%.
Using these numbers, the PEG ratios for Pro Medicus, Lovisa, and Netwealth would be 4.7x, 1.2x, and 2.3x, respectively.
Of course, this is not to say the above ASX growth shares will stop rising. They may continue rising, especially if they exceed market expectations through faster market penetration or cost savings. Some investors might prefer high-growth companies over cheap multiples.
With that said, the PEG ratio is a useful tool for finding undervalued stocks relative to their expected growth.
So, let's explore two ASX shares trading at below 1x PEG ratio today.
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Collins Foods Ltd (ASX: CKF)
Down 18% from the beginning of 2024, KFC operator Collins Foods appears to be in the value zone.
The consensus earnings estimates by S&P Capital IQ imply the company's EPS will increase from 51 cents in FY24 to 74 cents in FY26 at a two-year CAGR of 20%.
Collins Foods shares are currently trading at an FY25 PE of 15x, giving us a PEG ratio of 0.7x.
Yesterday, the company reported strong results for FY24, with its revenue rising 10.4% to $1,489 million, excluding divested Sizzler Asia, and underlying earnings before interest and tax (EBIT) up 15% to $124.1 million. The robust results were driven by continued strength in the KFC Europe business.
The Collins Foods share price closed on Tuesday at $10.00.
Corporate Travel Management Ltd (ASX: CTD)
As its name suggests, Corporate Travel Management is a global provider of innovative and cost-effective travel solutions for corporate clients.
Corporate Travel Management shares have dropped 23% over the past year, putting its forward P/E ratio at just 14x. This is fairly low, considering its P/E ratio was 11.5x in March 2020 at the height of the COVID-19 pandemic.
Based on estimates by S&P Capital IQ, the market predicts its EPS will grow from 86 cents in FY24 to $1.13 in FY26. This implies a two-year CAGR of 15% and a PEG ratio of 0.9x.
Now, as my colleague Bernd highlighted, ASX 200 travel shares are experiencing some headwinds from fuel costs. While airlines would take a direct hit from the fuel charges, higher ticket prices can impact travel demand.
On the flip side, these ASX travel shares, including Corporate Travel Management, can benefit from the government's cost-of-living relief measures, as Bernd added.
If analysts' current EPS estimates are accurate, Corporate Travel Management shares appear cheap based on the PEG ratio.
Corporate Travel Management shares closed on Tuesday trading at $13.72.
