So why, then, should VMware, whose software makes data centers more efficient, and its 2.46 PEG be any different? Good question, Fool. The difference is that VMware produces more free cash flow than it does net income.
Behold:
| Metrics |
Trailing 12 Months |
2006 |
2005 |
2004 |
| Net income* |
$171.00 |
$85.90 |
$66.80 |
$16.80 |
| Income as % of revenue |
14.90% |
12.20% |
17.30% |
7.70% |
| Free cash flow* |
$279.20 |
$227.30 |
$217.50 |
$88.00 |
| FCF as % of revenue |
24.40% |
32.30% |
56.20% |
40.20% |
Source: Capital IQ, a division of Standard & Poor's.
*Numbers in millions.
Notice the difference? Lower income skews the PEG and makes it look a lot more unreasonable than it really is. So let's come up with a better measurement: P/FCF-G, or price-to-free cash flow-to-expected growth. As with the PEG, 1.0 or lower is best, though 1.5 or lower is just fine for most high-growth stocks.
By my math, VMware's P/FCF-G for 2008 is 1.69.
Read the entire article from Motley Fool, here.