Price/Earnings to Growth

The Price/Earnings to Growth (PEG) Ratio is a financial metric that evaluates a company’s price-to-earnings ratio relative to its expected growth rate. It helps investors determine the value of a stock while considering future earnings growth, providing a more comprehensive view than the standard price-to-earnings (P/E) ratio alone.

Understanding PEG Ratio

The PEG Ratio is calculated by taking the P/E ratio of a company and dividing it by its projected annual earnings growth rate. This ratio is particularly useful for comparing companies with different growth rates and for assessing whether a stock is overvalued or undervalued based on its growth potential.

Calculation of PEG Ratio

To calculate the PEG Ratio, follow these steps:

1. Determine the company’s P/E Ratio: This can be calculated by dividing the current share price by the earnings per share (EPS).

• P/E Ratio = Current Share Price / Earnings Per Share

2. Estimate the company’s expected growth rate: This is commonly expressed as a percentage and typically reflects projected earnings growth over a certain period, often the next five years.

3. Calculate the PEG Ratio: Divide the P/E Ratio by the growth rate (expressed as a whole number, e.g., 15% growth rate is 15, not 0.15).

• PEG Ratio = P/E Ratio / Expected Growth Rate

Example of PEG Ratio Calculation

Let’s consider a hypothetical company, XYZ Corp:

– Current share price = $50
– Earnings per share (EPS) = $2.50
– Expected annual earnings growth rate = 20%

Step 1: Calculate the P/E Ratio

• P/E Ratio = Current Share Price / Earnings Per Share
• P/E Ratio = $50 / $2.50 = 20

Step 2: Use the expected growth rate of 20%.

Step 3: Calculate the PEG Ratio

• PEG Ratio = P/E Ratio / Expected Growth Rate
• PEG Ratio = 20 / 20 = 1

Interpreting the PEG Ratio

The PEG Ratio can be interpreted as follows:

– A PEG Ratio of 1 suggests that the stock is fairly valued relative to its growth rate.
– A PEG Ratio less than 1 could indicate that the stock is undervalued and may provide a good investment opportunity, as the price is low relative to growth prospects.
– A PEG Ratio greater than 1 may suggest that the stock is overvalued, as investors are paying more for each unit of expected growth.

Understanding the PEG Ratio can aid investors in making more informed decisions about stock investments by taking both the current price and the future growth potential into account.