Value Peg

Q: Is there an easy way to find out if a big company is overvalued or undervalued?

--Sally Duncan, Austin, Texas

A: Try using the YPEG, a year-ahead price/earnings-to-growth rate ratio. It’s a nifty way to find an approximate fair value for larger, more established companies.

Let’s calculate a YPEG for Sears, for example. Take next year’s earnings per share estimate of $3.74 and multiply it by the expected five-year annual growth rate of 15%. This gives you a YPEG fair value of $56.10. With Sears currently trading around $47 per share, this yardstick suggests that it’s undervalued.

The YPEG is one of many valuation measures in a Fool’s toolbox, but never the only one. And it doesn’t work for small, young companies, as their future earnings are less predictable. You can get earnings estimates and growth rates at your library, in First Call or Zacks publications. Online, our Web site at https://www.fool.com offers earnings estimates, and growth rates can be found at https://www.smartmoney.com.

*

Q: Why do I sometimes hear people chuckling about tulips when they’re discussing investing?

--Attison Barnes, Washington, D.C.

*

A: While the Pilgrims were settling down in Massachusetts, people in Holland were bidding higher and higher prices for tulip bulbs. This great “tulipmania” episode of the mid-1600s is one of the first documented cases of a speculative investing frenzy. Incredibly, people were taking out loans on their homes in order to buy bulbs they didn’t intend to plant but only to resell. Prices soared to the modern-day equivalent of tens of thousands of dollars per bulb. Eventually, the proverbial bubble burst, wiping out many investors. The easiest way for a Fool to avoid “tulipmania” is to avoid borrowing money to invest.