definedtobetheprice-earningsratiodividedbytheexpected
growth rate in earnings per share:
Forinstance,afirmwithaPEratioof 20 andagrowthrateof
10 percentisestimatedtohaveaPEGratioof2.Consistency
requiresthegrowthrateusedinthisestimatebetheexpected
growthrateinearningspershareornetincome,ratherthan
operatingincome,becausethisisanequitymultiple.Given
themanydefinitionsoftheP/Eratio,whichversion should
weusetoestimatethePEGratio?Theanswerdependsonthe
baseonwhichtheexpectedgrowthrateiscomputed.Ifthe
expected growth rate in earnings per share is based upon
earningsinthemost recent year(current earnings),thePE
ratiothatshouldbeusedisthecurrentPEratio.Ifitbasedon
trailingearnings,theP/EratiousedshouldbethetrailingP/E
ratio. The forward P/E ratio should never be used in this
computation, since it may result in a double counting of
growth.
5 Thecross-sectional distribution of PEGratios across all
U.S. firms in January 2006 is examined inFigure 8.2.
FIGURE8.2PEGRatioDistribution—U.S.StocksinJanuary
2006