# Calculate and Interpret the PEG Ratio

The *PEG ratio* (Price/Earnings to Growth ratio) is a valuation metric used to measure the trade-off between a stock’s price, its earnings per share (EPS), and the expected growth of the company. While the price/earnings (P/E) ratio is closely tracked to determine whether a stock is over or under-priced, the PEG ratio incorporates the earnings growth rate to better measure the potential value of a stock.

#### Revisiting the P/E Ratio

The P/E ratio (price-to-earnings ratio) of a stock is used to measure the price paid per share against the profit earned by the company on a per share basis. The higher the P/E ratio, the more investors are willing to pay for each dollar of earnings the company generates. A high P/E ratio indicates an abundance of investor optimism for that sock. As a valuation measure, though, the P/E ratio can be misleading. Low P/E ratio stocks are often “cheap” for good reason and a high P/E ratio doesn’t always mean that the stock is overpriced. Many investors prefer to analyze the PEG ratio over the P/E ratio because it incorporates the expected earnings growth rate into the valuation.

#### Calculating and Interpreting the PEG Ratio

Popularized by the great investor an author Peter Lynch, the PEG ratio is widely utilized by investors to estimate the true value of a stock. The ratio is particularly popular with investors who are intent on executing a Growth at a Reasonable Price (GARP) strategy. The formula for the PEG ratio can be written as:

##### PEG Ratio = Price to Earnings Ratio / Annual Earnings per Share Growth

A PEG ratio of 1 (theoretically) indicates that the stock is fairly priced. A ratio between .5 and less than 1 is considered good, meaning the stock may be undervalued given its growth expectations. A ratio less than .5 is considered to be excellent.

#### To Use the PEG Ratio Calculator Below

(1) To get the P/E ratio information for a stock, go to Yahoo! Finance and enter the stock symbol in the *Get Quotes* window.

(2) To get the growth estimates, go to MSN Money and enter the stock symbol in the *Get Quote* window. On the left-hand side, click on *Earnings Estimates* under *Fundamentals*.

#### Downside to the PEG Ratio

The PEG ratio provides an approximation that is highly dependent on the judgment of the investor in choosing a growth rate. Shifting competitive and market conditions can have unforeseen impacts on the anticipated growth rate of a company. Also, the measure is of little value to larger, more mature companies whose real value may be in the income they provide to investors through dividends.

#### The Stock Research Pro Valuation Software

The SRP Valuation software offers three modules to assess the value of a stock and the health of a company:

• Discounted Cash Flow (DCF)

• Net Current Asset Value per Share (NCAVPS)

• Dividend Discount Model (DDM)

Each module includes a video tutorial to guide you through the process.

*SRP Valuation*introduction video

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The above information is educational and should not be interpreted as financial advice. For advice that is specific to your circumstances, you should consult a financial or tax advisor.

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