isadirectresultoftheassumptionoflinearitymadeinthe
PEGratio;afterall,iflinearityheld,thePEGratioforafirm
with an expectedgrowth rate of 0 should also be 0. The
secondisthat,unlikeothermultipleswherethedirectionof
therelationshipbetweengrowthandthevalueofthemultiple
ispredictable,theeffectofgrowthonPEGratioscanvary
dependingontheexpectedgrowthratesbeingcompared.Put
anotherway,whencomparing twocompanies,one withan
expected growth rate of 4 percent and the other with an
expectedgrowthrateof 15 percent,weknowthatthePEG
ratiowillbias usagainstthelower-growth firmandtoward
the higher-growth firm. However, when comparing two
companieswithexpectedgrowthratesof 30 percentand 40
percent,thePEGratiomaybiasusagainstthehigher-growth
firm and toward the lower-growth firm.
Theeffectofchangesintheexpectedgrowthrateonequity
multiplescan also vary depending on thelevel of interest
rates.Theintuitionforthis isstraightforward.Thevalueof
growthliesinthefuture,andasinterestratesrise,thevalueof
expected growth decreases. Consequently, surprises about
expectedgrowthhaveabiggerimpactwheninterestratesare
lowthanwhentheyarehigh.ThisisillustratedinFigure8.6,
wherewelookattheimpactofchangingtheexpectedgrowth
rate ontheP/E ratio under fourdifferent riskless rates—4
percent, 6 percent, 8 percent, and 10 percent.
FIGURE 8.6Risk-Free Rate and P/E Ratios