The price/earnings to growth ratio (PEG ratio) is the price-to-earnings (P/E) ratio of a stock divided by the earnings growth rate over a given time period. Investors and analysts used this ratio to determine the value of the stock. However, it also takes into account the company’s expected earnings growth. It can provide a more complete picture than the more common P/E ratio.
Calculating The PEG Ratio
To calculate this ratio, an investor or analyst must first look up or calculate the company’s P/E ratio. Furthermore, to calculate the P/E ratio is by dividing the company’s share price by its earnings per share (EPS).
After calculating the P/E, determine the expected growth rate for the stock in question. You can also find the growth rates by using analyst estimates available on financial websites that follow the stock. Input the figures into the equation and solve for the PEG ratio.
PEG Ratio= P/E ratio / EPS Growth
What This Ratio Tells US
While a low P/E ratio may make a stock appear to be a good buy, factoring in the company’s growth rate to calculate the stock’s PEG ratio may reveal a different story. The lower the PEG ratio, the more the stock may be undervalued given its future earnings expectations. Including a company’s expected growth in the ratio helps to adjust the result for companies with a high growth rate and a high P/E ratio.
The degree to which a PEG ratio result indicates an overpriced or underpriced stock varies by industry and company type. However, some investors believe that this ratio less than one is preferable as a general rule.
A company’s P/E and expected growth should be equal. A PEG ratio of 1.0 indicates that it is fairly valued. Furthermore, when a stock’s PEG exceeds 1.0, it is considered overvalued, while a stock with a PEG less than 1.0 is considered undervalued.
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