Start from the price: what is already in it
A pitch does not begin with the company. It begins with what the price already believes, because the trade is the gap between that and your number.
- Turn a P/E into the growth the price is assuming
- Put the market's growth next to the street's and say which side the gap is on
- Price a stock at the multiple its expected growth deserves
- Explain why a pod analyst pitches a gap, not a company
The intuition
A restaurant charging $60 a plate is telling you it expects to be excellent. Whether dinner is a good deal has nothing to do with whether the food is good; it depends on whether the food beats what $60 already promises. Stocks are the same. A high multiple is not a verdict on the company, it is a promise the price has made on the company's behalf. Your job is to find out what was promised, and then decide whether the company will keep it.
The P/E is what the market pays for each dollar of earnings; it pays more when it expects those earnings to grow. Divide the P/E by the growth rate and you have the PEG, and if the sector has a going rate for a PEG, you can run it backwards: the P/E divided by that rate is the growth the price is assuming. Put that next to what the street (consensus) expects. If the price needs more growth than the street forecasts, the stock has to beat consensus just to stand still. If it needs less, consensus being right is enough.
Growth the price assumes = P/E ÷ (fair PEG × 100). The pitch lives in the gap between that number and the number you believe. On a multi-manager platform your edge is your number for the next few quarters, not a view on what multiple the market should pay.
Why it works
- The conventions here: PEG uses the trailing P/E and the expected annual EPS growth, with growth written as a whole number (15% is 15). The fair PEG is the sector's going rate, a judgment. No dividend adjustment.
- Consensus is the market's number, not the truth. It is the average of the sell-side models, and the price usually sits close to it. A pod analyst's edge is a different number for the next two to four quarters, backed by work the street has not done: channel checks, a pricing survey, a mix shift already visible in the filings.
- The gap has a sign. Growth the price assumes above the street's: the price needs a beat, so the burden of proof is on the long, and a short thesis starts here. Below the street's: the price is not even crediting consensus, so if the street is right the stock is cheap on the sector's PEG.
- The deserved price is the mirror image. Fair PEG × growth is the P/E the street's growth deserves; times EPS, the price. How far that sits from today is how much of the stock is expectation.
- Changing the fair PEG moves everything. Take it from 1.5 to 1.25 and the growth the price assumes rises by a fifth. The number is a lens on expectations, not a valuation, and the PM knows it.
- A low PEG is a question, not an answer. One year's bounce in earnings gives a low PEG with nothing behind it. Ask how long the growth lasts and how much of it turns into cash before you call it cheap.
| Growth the price assumes: 24 ÷ 1.5 | 16% a year |
| The street's growth | 12% a year |
| The gap | 4 points the company must find |
| P/E the street's growth deserves: 1.5 × 12 | 18x |
| Deserved price against today: 18 ÷ 24 − 1 | −25% |
On the street's numbers this stock is a short candidate. Whether it is a short depends on whether you believe 12% or 16%.
The formulas
Points of P/E per point of growth.
PEG run backwards: what the market must be expecting.
The multiple the street's growth deserves.
That multiple on today's earnings.
The multiple on next year's earnings.
Worked example
The price the street's growth deserves: the fair PEG times growth gives the P/E, times EPS gives the price. The last line compares it with today, which is the size of the expectation built into the stock.
See it move
Same company. Change the P/E, the growth the street expects, the PEG the sector calls fair, and the share price.
- Raise the P/E. The growth the price assumes rises: the price now needs more from the company. The P/E the street's growth deserves does not move.
- Raise the street's growth. The P/E and the price it deserves rise; the growth the price assumes does not move, because it depends only on the P/E and the fair PEG.
- Raise the fair PEG. The growth the price assumes falls and the deserved P/E rises: a sector that pays more per point of growth needs less growth to justify today's price.
- Change the share price with the P/E held. Nothing in the gap moves; only the dollar figures rescale.
Run it backwards
The pitch's first sentence, run backwards: you know the P/E and the sector's fair PEG. What growth is the price assuming, and how does it compare with what the street expects?
PEG = P/E ÷ growth, so growth = P/E ÷ PEG. Put the fair PEG in and out comes the growth the price needs. The second line is the one the PM cares about: that number against the street's.
This is where a pod pitch starts. Not "it's a good company" but "the price needs 16% and the street has 12%, and here is why the street is right" or "here is why the company will do 18%".
Traps
Say it in the interview
“The stock is on 24 times. Is that expensive?”
Check yourself
4 fresh questions, with new numbers. Answer each one correctly to finish the chapter. Get one wrong and you will see the full working, then you can try it again with new numbers.
Answers within 1% are marked right. Type the number; $, %, x and M are fine. First tries count toward Learned: the topic is Learned once every chapter is done and 75% of first tries were right.
- Growth the price assumes = P/E ÷ (fair PEG × 100).
- The pitch is the gap between that and your number for the next few quarters.
- Above the street: the price needs a beat. Below: consensus being right is enough.
- The fair PEG is a judgment; say where it comes from.