Last week we reviewed the forward P/E (price/earnings) ratio of the S&P 500. This week we are going to examine a derivation of the P/E ratio, the PEG ratio. The PEG ratio is (P/E) over the long-term growth rate, and it can give a different perspective on equity prices. The lower the PEG ratio, the more an individual stock or a stock index may be undervalued relative to its earnings projection. The chart above shows that the NTM (next twelve months) forward PEG has quickly climbed back to near its 10-year average in the last two months. Remember also from last week that the NTM forward P/E ratio is above its 10-year average. What does this all mean? Long-term growth rates (the denominator of the PEG ratio) may be slowing again. This suggests that the market could become overvalued quickly based on this metric. We saw last week that the P/E ratio with its above-average reading was flashing the same warning signal. After one year of stimulus, it is possible that the financial markets are back to thinking about thorny long-term issues: slowing growth in China, near recession conditions in Europe, political uncertainty, and the death of loose monetary policy across much of the developed world.
The chart below looks at the same variable — projected sales of S&P 500 companies — we analyzed in the last newsletter. After an additional week of financial reporting data, this estimate and the estimate of future corporate earnings are still trending down. The revenue warnings are coming in on past market darlings, and it is currently causing a shakeup of the leaders at the top of the market.