If you’ve ever bought clothes for a toddler, you know how tricky it can be to predict growth rates. It gets even harder if you hope to take advantage of seasonal clearance sales, since you have to guess how big your child will be months from now. Hit the right size and you scored a deal; guess wrong and not only will you waste money—you’ll pay full price to replace it.
Predicting which companies are going to expand fastest is just as tricky. Fortunately, there is at least some data you can turn to for guidance. That’s where the price-to-earnings growth, or PEG, ratio comes in. The ratio was popularized in the 1980s by Peter Lynch, a Wall Street legend who averaged 30% returns over more than a decade. The PEG ratio takes the forward price-to-earnings ratio and divides it by that company’s future annual earnings-per-share growth rate. The lower the ratio, the cheaper the stock should be, based on its expected growth.
Ideally, the PEG ratio should be less than one. If we applied such a strict condition to the Investor 500 this year, we’d be looking at a pretty short list. That should tell you something about the current growth prospects in this market. Normally explosive growth is associated with high-flying tech companies, but these can come with stratospheric valuations. As a result, when applied to Canadian stocks, the PEG screen tends to come up with older companies seldom characterized as high-growth stocks. But looks can be deceiving. Consider convenience store operator Alimentation Couche-Tard, which appeared on our 2015 list. Since then, it has returned 19.5.
A pair of forest companies post the lowest PEG ratios on our list this year. The forest industry has been hobbled by slowing Chinese demand. Canfor Corp. and West Fraser Timber have also been constrained by the mountain pine beetle infestation in B.C. and environmental challenges in Quebec. But these constraints could be a positive for the industry, as U.S. housing construction returns to normal levels. Just remember, growth can be tricky to gauge. The PEG is a good starting point, but it’s worth considering where the growth may come from before you buy your kid a winter coat in June.
|Cogeco Communications Inc.||CCA||0.6||9.3||4.9||67.9|
|Gildan Activewear Inc.||GIL||1.4||14||8.8||119.8|
|Magna International Inc.||MG||0.7||12.8||-6.6||70.2|
|Power Financial Corp.||PWF||0.8||6||-12.6||12.3|
|Royal Bank of Canada||RY||1.3||4.2||3.6||19.7|
|West Fraser Timber Co. Ltd.||WFT||0.4||16.8||6.3||44.3|