The price-to-earnings-to-growth (PEG) ratio shows that Tesla, Google, Netflix, and Apple are undervalued.
The most popular measure to value a company is the price-to-earnings (P/E) ratio, which shows the stock’s current price divided by its latest earnings per share.
Although it is a valuable measure, it does not incorporate the company’s earnings and revenue growth rate.
The importance of growth is illustrated by the recent drop in Tesla’s share price, which has sparked renewed debate over whether it is now the bargain of the decade or still overpriced.
While Tesla’s price-to-earnings (P/E) ratio is still 56, the share price might be justified based on its strong growth.
It is also important to remember that Tesla is at an early stage of its business cycle and only turned profitable in 2019. Its growth is unlikely to continue at such a high rate.
A good way to account for growth rates in seeing whether a stock is cheap or expensive is to use the price-to-earnings-to-growth (PEG) ratio.
The PEG ratio divides the P/E ratio of a stock by the percentage growth rate of its earnings for a specified period.
It gives a better picture of the fair value of a company. A number bigger than one is considered overvalued, while a number smaller than one is considered undervalued.
The PEG ratio is sensitive to the growth rate chosen, and it is up to the discretion of the investor over which period they want to evaluate the growth rate.
For the purposes of this evaluation, the growth rate over the past two years was taken based on the data from the last 12 quarters.
Based on the PEG ratio, Tesla can be considered undervalued at 0.17. It is due to earnings starting from a low base after it just turned profitable.
However, Tesla has also been able to grow revenue by more than 50% per year while keeping its operating expenses relatively stable by continuously improving its operating efficiency.
It has been a key factor in its ability to grow earnings so quickly. Even if revenue growth is used for the PEG ratio to temper expectations, Tesla is still around the fair value range.
Google, Apple, and Netflix are also all undervalued based on the PEG ratio, while Microsoft still seems overvalued as its earnings growth rate lags behind its peers.
Netflix had the lowest growth in revenue among the FAANG stocks over the past two years, and if that starts weighing on its earnings growth potential, then it could be considered overvalued.
Meta is considered overvalued despite dropping 70% in price and trading at a P/E ratio of only 11.
Uncontrolled growth in expenses led to weak earnings growth of only 9% despite revenue growing 25% per year.
If Meta can get costs under control and earnings can grow anywhere close to the same rate as revenue, it will be a very good buy.
Based on these metrics, Amazon’s share price still poses a significant downside risk. It is the only FAANG stock with negative earnings growth.
Amazon’s earnings declined by 20% per year over the past two years and dropped nearly 60% over the past year.
Amazon has the highest P/E ratio at 87. Even if the growth in revenue over the past two years is used, it will result in a PEG ratio of 4.4, which is considered extremely overvalued.
However, Amazon has sustained such high valuations for many years already. Revenue growth of 20% is still strong by most standards, and Amazon still controls a significant market share in all its business segments.
Management is also likely to intervene by controlling costs, as CEO Andy Jassy has already been doing.
PEG ratio comparison for mega-cap tech shares
|Share price drop from peak||55%||28%||58%||49%||17%||34%||70%|
|PEG Ratio (EPS)||0.17||1.19||0.76||N/A||0.67||0.51||1.15|
|PEG Ratio (revenue)||1.07||1.43||1.73||4.43||1.02||0.66||0.42|