Valuation techniques often suffer from the problem of 'rubbish in, rubbish out'. Compelling but complex methods of valuing stocks, such as discounted cash flow (DCF) models, are often regarded as being particularly susceptible to producing rubbish valuations given the potential to base calculations on rubbish assumptions. In the case of DCF, such assumptions range from judgements about appropriate long-term discount rates through to financial forecasts stretching many years out into an unpredictable future.
Given the vast extent of the uncertainties investors face when trying to value shares, one of the key attractions of the price/earnings growth (PEG) ratio is that it keeps things simple as it attempts to weigh a valuation based on current earnings against prospects for future earnings growth. The basic PEG formula is:
PEG = price/earnings (PE) ratio / EPS growth rate