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
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.
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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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