When you compare the P/E ratio to the benchmark, let me just introduce a little bit of notation. That notation is basically the, P/E ratio, the benchmark that we're using, let me add a little star. That could be historical, that could be cross-sectional. The thing is, we're comparing the P/E ratio of the company we're interested in at this point in time with the benchmark and that benchmark we're calling P/E star. Let suppose, as is the case with Marriott, that the multiple is different from what it was in the past and it's different from what the competitors multiple is today. One of the things that we can do, one of the ways in which we can look into fundamentals to see whether there's any difference, and this is what is called the PEG ratio, and you'll see in a minute why it is called the PEG ratio. But just to give you an idea what this means, suppose we have two companies, and let's go hypothetical for just a minute. Where company A and company B, let's suppose that we observe, and obviously, let's think of two companies in the same sector, in the same line of business, and P/E ratio of company A is 10, P/E ratio of company B is 20. We could jump into the conclusion, A, these are two companies in the same sector, but one is much cheaper than the other. Maybe the first one, A, is more attractive than B. Well, that'll be not a simple analysis. That'll be a simplistic analysis, that we'll be comparing two multiples and conclude way too quickly, the A is the one that I want to buy and B is the one that I don't want to buy. Here's what the PEG ratio comes in. For example, suppose that I tell you also that, that over the next few years, the earnings of a company A are expected to grow only at 5 percent per year, but the earnings of company B are expected to grow at 20 percent per year. Well, you'd be more interested in B that in A, that's where the PEG ratio comes in and you'll see now where the name comes from, P, E and G. That is the PE divided by the expected growth. That P/E divided by the expected growth is one way of saying that we need to put that P/E relative to what we expect in terms of growth. If you divide now the two numbers, so if you divide the P/E ratio of A, which is 10 by 5, that gives me 2. If you divide the P/E ratio of B, 20 divided by 20, that gives me 1. Now, the PEG ration of B, 1, is lower than the PEG ratio of A, which is 2. Now, think about for a minute, what would you prefer, a high PEG ratio or a low PEG ratio? Well, everything else equal, a higher PEG ratio means that you're either paying more or that the G is lower. That is that the company is expected to grow less quickly than the other one, so everything else equal. The lower the PEG ratio, the better, because either you're paying less or the company is expected to grow more quickly. Now, we started from company A being cheaper than company B, but once we adjust by the expected growth, what we have is that adjusted by growth may be company B is more attractive than company A. This is one simple way of illustrating the real work that an analyst has to do other than just comparing two numbers, other than just comparing two P ratios, we need to be able to adjust by fundamentals. We need to be able to take into account the fundamentals of the company when we do that. Remember, everything else equal the lower the PEG ratio, the better because either you're paying less or you're growing more aggressively. I don't want to make too much out of this, but this comes from Peter Lynch, the venerable Manager of Fidelity Magellan, at the end of the 80's, he used to use the PEG ratio quite a bit, and he had in the back of his mind, PEG ratio of one. Meaning that if accompanies PEG ratio is higher than one. Maybe it's on the overvalued side, and if it's lower than one, maybe it's on the undervalued side. We can go back once more to our Marriott comparison. This comes from Yahoo Finance by the way, and there you have the PEG ratio of 2.71. Now we have like three things pointing in the same direction. We have a trailing P/E, which is higher than what it was in the past. A trailing P/E that is higher than the competitors, and a PEG ratio which is quite a bit larger than one. These three things may, and I stress the word may indicate that Marriott is on the expensive side that you have to pay more for Marriott that you did in the past, that you have to pay more for merrier today than you pay for most of the competitors or at least for the average competitors, and that when you adjust by growth, then the PEG ratio tells you that maybe it's on the expensive side. Again, I don't want to make too much out of the PEG ratio equal to 1. But certainly in this case, that PEG ratio is substantially higher than you may find in some other companies today.
