Peter Lynch's strategy for all seasons

More than 80% of investment managers don't beat the market. Peter Lynch did it consistently over 13 years with Magellan. His secret: PEG ratios, and staying power.

20 September 07, John Reese

It stands to reason that professional mutual fund managers should be considerably more successful at picking stocks than the average investor. After all, people who have degrees in finance and years of practical experience in the market -- and who are willing to take your money in exchange for their expertise -- should be very good at what they do, right?

Unfortunately, many times that is not the case. In fact, my own research has shown that 80 to 90 percent of active fund managers fail to beat the market in the long term.

But there are, of course, fund managers who have proved you can beat the market over the long haul, and if you're looking for inspiration there's probably no better example than Peter Lynch. During his 13-year tenure as the head of Fidelity Investments' Magellan Fund, Lynch guided the fund to a 29.2 percent average yearly return -- nearly twice the 15.8 percent return that the S&P 500 posted during the same period. According to Barron's, over the last five years of Lynch's tenure, Magellan beat 99.5 percent of all other funds. Looked at another way, if you had invested $10,000 in Magellan the day Lynch took the helm, you would have had $280,000 on the day he retired 13 years later.

How did Lynch achieve such success where so many other professional investors failed? Interestingly, a big part of his approach involved something that is not at all exclusive to being a renowned professional fund manager: He invested in what he knew. Lynch believed that if you personally know something positive about a stock if you buy the company's products, like its marketing, etc. -- you can get a beat on successful businesses before professional investors get around to them. In fact, one of the things that led him to one of his most successful investments -- undergarment manufacturer Hanes -- was his wife's affinity for the company's new pantyhose years ago.

Investing in what you know is really just a starting point for Lynch, however. His strategy also has many quantitative aspects, and I was so impressed by it that it became the basis for one of my "Guru Strategies", computer models each of which mimics the approach of a different investing great. Here's a look at how my Lynch-based strategy works, and some examples of companies that fit the bill.

Different criteria on one PEG

An important aspect of Lynch's strategy is that he didn't apply the same rules to all stocks. He classified companies by their size and growth rate (and sometimes by the nature of their business), and used different sets of criteria to analyze these different groups.

His favorite type of investment was "fast-growers" -- companies whose earnings have been increasing at a rate of 20 to 50 percent per year. Other groups he focuses on in his book are large "stalwarts", which grow at a more moderate pace, and "slow-growers", which have single-digit growth rates but are attractive for their high dividend payouts.

Before I examine what Lynch looks for in each of these categories of stocks, however, I should note that there is one variable that Lynch considers crucial no matter what the stock's classification: the P/E/Growth ratio.

While the price/earnings ratio (which compares a company's per-share price to its per-share earnings) may be the best-known stock market variable, Lynch found that looking at the P/E ratio by itself was less useful than looking at it in comparison to a company's growth. The rationale was that higher P/E ratios are okay, provided that the firm is growing at an appropriate pace. If a company's P/E ratio was about even with or less than its growth rate (i.e. P/E divided by growth rate equals 1.0 or less), Lynch saw that as acceptable

Lynch found that this P/E/Growth ratio -- or "PEG" -- was a great way to identify growth stocks that were still selling at good prices. In fact, the P/E/G ratio became the most important variable he considered when looking at a stock, and his reliance on it is one of the things he is most known for in the investing world.

To show how the P/E/G can be more useful than the P/E ratio, Lynch cited Wal-Mart, America's largest retailer. In his book "One Up On Wall Street", he notes that Wal-Mart's P/E was rarely below 20 during its three-decade rise. Its growth rate, however, was consistently in the 25 to 30 percent range, generating huge profits for shareholders despite the P/E ratio not being particularly low. That also proved another one of Lynch's tenets: that you have plenty of time to identify and invest in exceptional growth companies, even after they have exhibited years, or even a decade, of rapid growth and have become quite large.

An example of a company with a very strong P/E/G ratio is energy giant Exxon Mobil (NYSE:XOM), which has a P/E of 12.15. When we divide that by its growth rate of 31.69 percent (based on the average of its three-, four-, and five-year earnings per share growth figures), we get a P/E/G ratio of 0.38. This not only betters my Lynch-based model's 1.0 maximum; it also falls into the strategy's best-case category (0.5 or below).

Fast-growers

Now let's take a look at those three categories I mentioned earlier, beginning with fast-growers. Exxon Mobil is an example of one such stock, because of its 31.69 percent growth rate.

For fast-growers, Lynch looks not only at the P/E/G, but also at the P/E ratio by itself. For large companies -- which my model views as those with annual sales greater than $1 billion -- he likes to see P/E ratios below 40, because he found that larger companies have trouble maintaining high enough growth to support P/Es over that threshold. (Smaller firms can have very high P/E ratios during their growth years, however).

Another quality Lynch looks for in fast-growers is manageable debt. He likes companies that are conservatively financed, and my Lynch-based model calls for debt to be no greater than 80 percent of equity. Exxon again makes the grade, with a debt/equity ratio of 7.56 percent.

An even better example of a fast-grower that meets this criterion is computer software power Microsoft (NASD:MSFT). Microsoft has no long-term debt, which my model considers exceptional. (Its 0.89 P/E/G ratio is another reason it passes my Lynch-based method.)

Lynch also made an astute observation about inventory, which can be applied not only to fast-growers but to other firms as well. He viewed it as a red flag when inventory increased more quickly than sales. (Inventory piling up indicates the products aren't as in-demand as the company had hoped.) My Lynch-based model thus likes the inventory/sales ratio to stay the same or decrease from year to year, but will allow for an increase of up to 5 percent if all other financials are in order. Exxon's inventory/sales ratio increased by just 0.32 percent this year while Microsoft's dropped by 1.13 percent, so each passes the test.

One caveat about "fast-growers": to Lynch, there is such a thing as too much growth. When a firm's historic growth rate is greater than 50 percent, he avoids it. Growth that high is unlikely to be maintained over the long run, and an investor shouldn’t pay for a stock on the basis of the assumption that a growth rate this high or higher will be maintained for long.

Stalwarts

Because of their large size (sales in the multi-billion-dollar range) and moderate earnings growth rate (10 to 19 percent per year), Lynch always keeps a few stalwarts in his portfolio, as they offer protection during recessions or hard times. An example of a stalwart that my Lynch-based model likes is credit card giant American Express (NYSE:AXP), which has a growth rate of 18.1 percent (again based on the average of the three-, four-, and five-year EPS growth rate figures) and annual sales of $29.8 billion.

One of the main differences between stalwarts and fast-growers is that dividends are often important for stalwarts, so Lynch adjusted the earnings portion of their P/E/G calculations for dividend yield. (He makes this adjustment by adding the yield, 1.01%, to the growth rate in the P/E/G formulathe yield supplements the EPS growth.) American Express's yield-adjusted P/E/G is 0.93, which comes in under my model's 1.0 upper limit.

Lynch also looked at debt for stalwarts, and my model again calls for debt to be no greater than 80 percent of equity.

When it comes to financial companies like American Express, however, debt is often a required part of business. Recognizing this, Lynch didn't apply the debt/equity ratio to financials. Instead, he looks at how a company's equity compares with its assets for a sign of financial health, and at how much of a return it is generating on those assets for a sign of its profitability.

The model I base on Lynch's writings calls for financial firms to have an equity/assets ratio of at least 5 percent, and a return on assets of at least 1 percent. At 8 percent and 3.18 percent, respectively, American Express passes both tests. (Note that while American Express is a stalwart, the equity/assets and return on assets figures are used for fast-growing and slow-growing financials as well.)

Slow-growers

Lynch was less keen on slow-growers and their single-digit growth than he was on fast-growers or stalwarts. But they can have high dividend yields, so they may be a good option if you're investing for income.

Lynch liked slow-growers to be large companies, so the model I base on his writings requires their sales to be greater than $1 billion. Just as with stalwarts, the P/E/G ratio for slow-growers is adjusted for dividend yield, and the debt-equity ratio should be below 80 percent (unless the firm is a financial).

One key difference when it comes to slow-growers: Because by definition they don't post big earnings increases, their dividend yields must be greater than 3 percent or greater than the yield of the S&P 500, whichever is larger.

Few slow-growers currently pass my Lynch-based model, but one that does is the US financial firm Comerica (NYSE: CMA), a Texas-based company that offers banking and financial management services in the US, Canada, and Mexico. Comerica's growth rate (7.34 percent, based on the average of the three-, four-, and five-year EPS figures) and high sales ($3.6 billion) make it a slow-grower, and its yield of 4.78 percent (which more than doubles the S&P's current 2.09 percent yield) is one reason my Lynch strategy considers it a good slow-grower. In addition, Comerica's yield-adjusted P/E/G is an acceptable 0.91, its equity/assets ratio is a healthy 9 percent, and its ROA is a strong 1.32 percent.

Be ready for all weathers

There is another critical aspect of Lynch's approach not specifically included in my quantitative model. It's simple in theory, but in practice it is one of the hardest things for an investor: Stay in the market.

Lynch recognized that the stock market was unpredictable in the short term, even to the smartest investors. In fact, he once said in an interview with American television station PBS that putting money into stocks and counting on having nice profits in a year or two is like "just like betting on red or black at the casino. ... What the market's going to do in one or two years, you don't know."

Over the long-term, however, good stocks rise like no other investment vehicle, something Lynch recognized. His philosophy: Use a proven strategy and stay in the market for the long term and you'll realize those gains; jump in and out and there's a good chance that you'll miss out on a chunk of them.

That, of course, means resisting the temptation to bail when the market takes some short-term hits, no easy task. But as Lynch once said, "The real key to making money in stocks is not to get scared out of them." If you have the fortitude to follow that advice -- and the discipline to follow Lynch's quantitative blueprints -- your portfolio should be much the better for it.

http://www.globes.co.il/serveen/globes/docview.asp?did=1000256306&fid=3011

Published by Globes [online], Israel business news - www.globes.co.il - on September 20, 2007

Ranking Stocks using the PEG Ratio

PEG = PE / EPS Growth Rate

PEG Ratio Key Points
1. Less reliable for large low-growth companies.
2. Estimates can differ from future realities.
3. Compare individual PEG Ratio to industry and market averages.
4. Beware of speculative and low-dollar stocks with low PEG Ratios.

PE/G ratio

Some investment strategies seek growth for its own sake or growth for the sake of growth rather than growth for the sake of value. 


Wall Street wisdom (pardon the oxymoron) adheres to the KISS principle as its highest virtue: Keep It Short and Simple. Most highly prized by brokers are slogans that fit easily on t-shirts and bumper stickers. 


As an example, one popular investment rule of thumb is that for a fully and fairly valued growth stock, the stock's price-to-earnings ratio should be equal to the percentage of the growth rate of the earnings per share of the associated company, i.e. PE = G. As with any such rule of thumb, this is not only superficial but also arbitrary and capricious. 


A common screen based on this heuristic is the ratio of the PE ratio to the EPS growth rate, or the PE/G. In an effort to better fit the historical performance of cyclical stocks and large-cap stocks, ad hoc variations on the PE/G ratio include 

• (1) using an estimated future growth rate instead of an historical growth rate or PE/FG, 
• (2) adding the dividend yield percentage to the EPS growth rate percentage or PE/DG, and 
• (3) adding two time the dividend yield percentage to the EPS growth rate percentage or PE/2DG.

When choosing a stock to buy, don't overlook the PEG ratio

The figurative earnings can indicate a bargain

Stocks

Dollars & Sense

April 02, 2000|By Laura Pavlenko Lutton | Laura Pavlenko Lutton,MORNINGSTAR.COM

Bankers are sticklers for the details. It's their business to invest money in loans to individuals and businesses, and they expect to be repaid, on time and in full -- no excuses.

As stockholders, we should think like bankers. When we buy shares in a company, we're making an investment, and we should be paid back, too. The payback for shareholders is figurative, of course, but consider how much a company would have to earn before its cumulative earnings equal its current stock price. That period is called the PEG payback period, and it's based on the PEG ratio: a firm's price/earnings ratio divided by its expected growth rate. The PEG payback period is the time it would take a company to pay back its investors with earnings.

Take Schlumberger, the oil- and gas-services company. It has a PEG payback period of 15.3 years, so at the company's expected growth rate, Schlumberger would have to add up its earnings per share for 15.3 years straight before those earnings would equal its current stock price. (Morningstar includes each stock's PEG payback period in the "stock valuation" portion of its Quicktake report.)

The PEG payback period is good for gauging whether a company's expected earnings justify its current stock price. A high PEG payback period generally means shareholders are paying for a company with relatively low earnings. Stocks with low PEG payback periods aren't risk-free, but they're cheaper based on expected future earnings.

For this week's analyst picks, we stayed with companies that have PEG payback periods of less than 11 years. One company worth noting is Alltel, the nation's fifth-largest wireless telephone carrier. The Little Rock, Ark.-based company has a PEG payback period of 10.6 years -- a figure that has increased recently with Alltel's stock price.

Alltel's appeal comes from its growing wireless network. The company recently inked a deal to buy wireless assets from Bell Atlantic and GTE, two companies that have been forced by regulators to divest some assets in conjunction with their merger this spring.

The deal will give Alltel customers inexpensive access to Bell Atlantic and GTE's wireless networks so Alltel phones may "roam," or operate on the other companies' infrastructures, at a low cost. Alltel's sales growth has been outpacing the telecommunications-industry average. The company has also posted strong profitability ratios, which earns it B-plus grades from Morningstar for profitability.

Another PEG-payback qualifier is Tyco, the conglomerate that fell out of favor last year due to questions about past accounting practices. Those still-unproven accusations tarnished Tyco's reputation, but with a PEG payback period of 8.1 years and an otherwise solid track record, this company may be worth a look.

http://articles.baltimoresun.com/2000-04-02/business/0004080794_1_payback-periods-peg-ratio-alltel

Calculating a Stock’s Risk-Reward Ratio by Jim Cramer

Calculating a Stock’s Risk-Reward Ratio
Published: Tuesday, 30 Aug 2011
By: CNBC.com


Focusing on a stock’s upside without giving proper consideration to potential losses, Cramer said Tuesday, can be “a grave mistake.” Too often people think only of the reward, without assessing the risk. And investors must calculate both.

“Because the pain from a big loss,” Cramer said, “hurts a whole lot more than the pleasure from an equivalent-sized gain.”

But how do you figure out the risk-reward on a stock? As a general rule, Cramer looks at the lowest price that a value-oriented money manager would pay for that stock to calculate the downside. For the upside, he uses the most a growth-focused manager would pay.

To arrive at these numbers, Cramer refers to something called “growth at a reasonable price,” or GARP, a method of stock analyzing first popularized by Peter Lynch. If you want to know just how much growth investors will pay, you need to understand GARP. And it involves a comparison of a stock’s growth rate to its price-to-earnings multiple.

But you can use this rule of thumb to figure out the value side of the equation, too, and here’s how Cramer does it: If a stock has a price-to-earnings multiple (PE) that’s lower than its growth rate, it’s probably cheap. And any stock that’s selling at a multiple that is twice the size of its growth rate or greater is probably too expensive and should be sold.

Example: A stock trading at 20 times earnings with only a 10 percent growth rate would be considered expensive. But the reverse—10 times earnings on a 20 percent growth rate—would be incredibly cheap.

This gives rise to another piece of Wall Street jargon: the PE-to-growth ratio, or PEG, which is the multiple divided by the stock’s long-term growth rate. A PEG of one or less is “extremely cheap,” Cramer said, while a PEG of two or more is “prohibitively expensive.”

This means then that the risk floor created by value investors will probably be somewhere near a stock’s PEG of one, while its ceiling, created by growth investors, rarely exceeds a PEG of two. That’s why Google [GOOG  570.11    -9.89  (-1.71%)   ] back between 2004 and 2007 was considered cheap, because its 30 percent long-term growth rate matched its 30 multiple. But if that multiple reached 60, growth managers would probably cash out of their positions.

There is one caveat to keep in mind, that this is a general rule of thumb, an approximation. But there are times when the numbers can be wrong. Cramer said stocks can look cheap based on earnings when those earnings estimates need to be cut, much like the banks and brokers were ahead of the 2008 crash. Or a stock could look cheap because its growth is slowing, like Dell[DELL  14.30    -0.53  (-3.57%)   ] after the dot-com collapse between 2000 and 2003. In these cases, the stock could trade well below a PEG of one, but that obviously doesn’t mean it’s a buy.

One final anomaly of multiples regards industrial companies, or cyclical names in general. The time to buy these stocks is when their multiples look outrageously high, Cramer said, because the earnings estimates are too low and read to be raised to catch up with their strengthening businesses.

(Written by Tom Brennan; Edited by Drew Sandholm)

http://www.cnbc.com/id/44334471/Calculating_a_Stock_s_Risk_Reward_Ratio

Short cuts for finding value

Companies and shares are worth the present value of the future cash they can generate for their owners.  This is a rather simple statement, and yet in practice, valuing companies is not so straightforward.

As the famous economist John Maynard Keynes put it, it's better to be vaguely right than precisely wrong, and the better bet is to stick to a few simple valuation tools.  Here are some ways to value companies or shares:

1.  Discount cash flow method.

2.  Asset-based valuation tools.

• Price/Book Value
• Graham's Net Current Asset approach

3.  Earnings-based valuation tools.

• PE ratio

4.  Cash flow-based valuation tools

• DY
• FCF Yield

These different valuation tools each have their own strengths and weaknesses.

• The price-to-book ratio tends to work best with low-quality businesses on steep discounts.  
• The PER tends to work best with high-quality growth companies.  
• The dividend yield and free cash flow yield tend to be suited to mature businesses generating steady returns.

But in every case, you'll probably get closest to the truth by looking at all the different measures.

Also, only invest in good quality businesses.

What is the PEG Ratio and How is it Calculated?

 The PEG or “Price/Earnings to Growth” ratio is a measure used to value a stock based on the trade-off between the P/E ratio of the stock and the company’s forecasted growth. Made popular by Peter Lynch in his book “One Up on Wall Street”, the PEG ratio is closely tracked by many investors to help determine whether a stock is currently over or under priced when factoring for growth expectations of the company.

The formula for the PEG ratio can be written as:

PEG Ratio = (Price/Earnings) / Annual Earnings per Share Growth

	Stock Research Pro
	PEG Ratio
	P/E Ratio
	Earnings Growth
	PEG Ratio

A PEG ratio equal to one is thought to represent a fairly valued stock. For example, a company with a P/E ratio of 20 with a growth rate of 20% would have a PEG of 1. Like the P/E ratio, stocks with lower PEG ratios are seen as offering better value and a PEG ratio of less than 1 can indicate that the stock is currently undervalued. Value investors in particular may look for this attribute when choosing stocks for investment.

The PEG ratio is typically most beneficial when considering small and mid-cap growth companies as these organizations are more likely to pour their earnings back into the company to stimulate continued growth. Large-cap companies often allocate these earnings to dividend payments.

__________________________

http://www.stockresearchpro.com/what-is-the-peg-ratio-and-how-is-it-calculated

Comparing P/E ratios to growth rates can be significantly more useful than simply comparing two companies' P/E ratios. Why?

Let's compare Company A to its competitor in the same industry Company B to illustrate.

Company A

Price $10

Last year's EPS $1.16

Projected EPS  $1.33


Company B

Price $ 8

Last year's EPS  $1.14

Projected EPS  $1.14


Using the data above, you can see that Company A's trailing P/E is 8.6, while Company B's is just 7.

Why would you want to pay $10 for Company A's earnings when you can get Company B's - the same amount, no less  - for $2 off?  (You could even take the $2 to give yourself a treat. )  :-)

Which company would you buy - Company A or Company B?  Why?

Answer:  Click here.

PEG Ratio: Why It’s More Relevant than P/E for Stocks

by DARWIN on APRIL 6, 2010

While many individual investors are familiar with the conventional Price to Earnings (P/E) ratio, the PEG ratio isn’t cited nearly as often but it really puts a stock’s valuation in the proper context.  While a P/E ratio will tell you whether a stock is “highly priced” just based on a forward earnings expectations or trailing earnings reports, a PEG ratio is the P/E ratio divided by the stock’s long term annual growth rate.  Now, the problem is estimating just what that growth rate will be.  But for relatively mature companies with transparent investor updates, it’s not too tough to reasonably discern whether you’re in the right ballpark.

PEG Ratio vs. P/E Ratio:

Consider two stocks.

1) Mature industrial company with steady earnings year over year.  P/E = 10.
2) Nimble, fast growing company. P/E = 45.

Let’s say the broad market is trading at an aggregate Price to Earnings ratio of 12.  One investor may view stock 1 as a “value” and stock 2 as being absurdly overpriced.  However, when looking at each in terms of their projected growth rate, the pendulum swings the other way.  If stock 1  is a utility that’s expected to grow at about 5% per year and stock 2 is growing at 30% per year, in the context of future growth, the PEG ratios tell a different story:

1) Stock 1 PEG ratio = 10/5 = 2
2) Stock 2 PEG ratio = 50/25 = 1.5

Stock 2 now appears to be much more of a value.  Often times, stocks with high growth rates are more volatile and prone to massive price swings.  But if you’re able to hang on to a stock for a few years and the projected growth rate assumptions are reasonable, you’re often rewarded with a higher net return.  This is broadly reflected in the long term outperformance of tech stocks, biotech stocks, small caps and emerging market stocks vs. their counterparts.

When I provided my last portfolio update you will have noticed that many holdings fall into the stock 2 bucket since I’m young and have a long time horizon and my ultimate goal is to maximize investment returns.  Conversely, when I’m 55 and approaching retirement, I will likely be more focused on stability and income via high yield investments.  So, there’s no “right” way to invest, but it’s important to consider the context of your investments as well as your time horizon.

Do You Use the PEG Ratio in Evaluating Stock Purchases?

http://www.darwinsfinance.com/peg-ratio/

Using PEG ratio: Not all growth is created equal.

As the risk increases, the PEG ratio of a firm decreases. When comparing the PEG ratios of firms with different risk levels, even within the same sector, the riskier firms should have lower PEG ratios than safer firms.

 

Not all growth is created equal. A firm that is able to grow at 20% a year, while paying out 50% of its earnings to stockholders, has higher quality growth than another firm with the same growth rate that reinvests all of its earnings back. Thus, the PEG ratio should increase as the payout ratio increases, for any given growth rate.

As with the PE ratio, the PEG ratio is used to compare the valuations of firms that are in the same business.  The PEG ratio is a function of:

• the risk,
• growth potential and
• the payout ratio of a firm.

http://zonecours.hec.ca/documents/A2009-1-1877347.ch18-earning-multiple(1).pdf

Earnings Growth, Earnings Yield and PEG

PEG relates, or normalizes, the PE to the growth rate.

• With PEG, apparently high PE ratios are supported by forward growth.
• PEG thus becomes a better tool to compare stocks with different PEs and different underlying growth assumptions.

By itself, it's hard to tell whether a PE is good or bad.

A stock with a PE of 30 may be a better deal than another stock with a PE of 15. Why? Because of growth.

• A stock of a no-growth company with a PE of 15 will never achieve an earnings yield beyond 7.5% (1/15).
• Meanwhile, the company with a PE of 30, with a growth rate of 20%, eventually achieves an earnings yield greater than 20%.

Enter the practice of normalizing PE by the growth rate.

• To do that, we divide all PEs by the company's growth rate to create a ratio known as (Price/earnings)/growth, or PEG for short.
• G is the growth rate, expressed as a whole number (that is, the percentage times 100).
• So, a company with a PE of 30 and a growth rate of 20% has a PEG of 1.5.

This gives a standard for comparison.

• Company A with a PE of 18 and a growth rate of 12% has the same PEG as Company B with a PE of 30 and a growth rate of 20%.
• Are the two PEs the same? 30 versus 18?
• Clearly not - until the underlying growth fundamentals are identified, apply PEG, and find out they are indeed priced equally.

The table below shows the relationship between future earnings yield, PE, and PEG. Watch what happens to PEG and future earnings yields as growth assumptions rise.

http://spreadsheets.google.com/ccc?key=toPlORpn7n23_xeRq2vYALQ

Low PEG ratios (less than 2) correspond to high future earnings yields.

You can see:

PEG = 2 scenario corresponds to a future earnings yield of 13%.
PEG = 1.30 correlates to 20%, and,
PEG = 1 correlates to a future earnings yield of 31% on today's investment price.

On the other hand, if:

PEG = 4, the implied future earnings yield is only 8.1%.

So, what is a "good" PEG ratio?

It all depends on the implied future rate of return you're looking for, which depends on

• (1) investment objectives,
• (2) risk tolerance, and
• (3) current risk-free (bond) interest rates.

A PEG of 2.7 or less: implies a future earnings yield of 10% or more.

A PEG of 2.7 or more: implies a future earnings yield of 10% or less. This is probably less return at more risk than most investors desire.

As a guide:

A PEG of 1 or less: this is great (but hard to find)

A PEG between 1 and 2: this is good.

A PEG between 2 and 3: this is marginal.

A PEG over 3: should probably be avoided.