Pe Not Price

A friend showed me two stocks over coffee last week. Both trading at a price to earnings of 20. Same price, he said. Pick whichever.

I asked him one question. How fast is each one growing.

Here is the thing nobody tells you about a P/E. On its own, it is half a number. It tells you what you pay for a rupee of today's earnings. It says nothing about what you actually get for it.

Stock A was growing earnings around 24 percent a year. Stock B, around 8. Divide the P/E by the growth rate and you get what people call PEG. Stock A lands at 0.83. Stock B at 2.50. Same sticker of 20, and Stock B is carrying three times the price per unit of growth.

Then I did the part that makes it real. Hold both for five years and let the earnings compound while the price stays put. The fast grower ends up priced like 6.8 times earnings on the money you put in. The slow one is still sitting at 13.6. Exactly twice as expensive. The two P/Es looked identical the day he showed me. Five years of growth split the value clean in half.

None of this makes a low PEG a free lunch. Growth is a forecast, not a receipt. A cheap PEG resting on a growth number that never shows up is just a high P/E that has not admitted it yet. But that is the point. You cannot even have that conversation while you are staring at a single number.

Same P/E is not the same price. One number is what you pay. The other is what you are paying for. Never read the first without the second.

More on reading a valuation without getting fooled by one number: