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.
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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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