PEG ratio

Summary

The PEG ratio is a key investing tool used to assess if a stock offers growth at a reasonable price. It builds upon the price-to-earnings (P/E) ratio by factoring in the company's earnings growth rate. By dividing the P/E ratio by the growth rate, investors can identify potentially undervalued stocks, with a PEG ratio below 1 often seen as a buying signal. However, the PEG ratio has limitations, including variations in how earnings and growth rates are measured. Investors are encouraged to use consistent sources when comparing PEG ratios across companies.

Takeaways

• 📊 The PEG ratio is a financial metric used to evaluate a stock's value by considering both its price-earnings ratio (P/E) and its earnings growth rate.
• 🧮 To calculate PEG ratio, divide the P/E ratio by the earnings growth rate expressed as a whole number, not a percentage.
• 💹 The P/E ratio is determined by dividing a company's share price by its earnings per share (EPS).
• 🔍 A PEG ratio below 1 might indicate that the stock is undervalued relative to its growth prospects, while a ratio above 1 could suggest overvaluation.
• 📈 Incorporating growth rate into the P/E ratio makes the PEG ratio a more dynamic tool for assessing a company's valuation.
• 📉 A PEG ratio can signal an undervalued stock if the company has a lower P/E ratio than the industry average but a higher growth rate.
• 🚫 The PEG ratio is not meaningful if the EPS or growth rate is negative.
• ⚖️ Investors use the PEG ratio as a rule of thumb to decide when to buy, hold, or sell stocks, with a ratio below 1 often prompting a buy decision.
• 💬 There is no standard method for calculating the PEG ratio, as different sources may use different EPS figures or growth rates.
• ⏱️ The choice of EPS and growth rate can vary, including historical, trailing twelve months, expected future, or a 5-year average.
• 🌐 When relying on investor websites for PEG ratio data, it's best to use a single source to ensure consistency and comparability across companies.

Q & A

What is the PEG ratio?

The PEG ratio is an investing rule of thumb used to find growth at a reasonable price by using the price earnings growth ratio.

How is the PEG ratio calculated?

The PEG ratio is calculated by dividing the P/E ratio by the earnings growth rate. For example, if a company has a P/E ratio of 10 and a growth rate of 25%, the PEG ratio would be 0.4.

What is the significance of the P/E ratio in the context of the PEG ratio?

The P/E ratio, or price-earnings ratio, is the starting point for calculating the PEG ratio. It represents how much investors are willing to pay per dollar of earnings.

How does the growth rate factor into the PEG ratio?

The growth rate adds dynamics to the P/E ratio by accounting for the change in earnings over time. It's used to adjust the P/E ratio to reflect the company's growth prospects.

Why is the PEG ratio considered a more dynamic measure than the P/E ratio?

The PEG ratio is considered more dynamic because it incorporates the growth rate of a company's earnings, providing a more comprehensive view of the stock's value relative to its growth potential.

What does a PEG ratio of 0.4 indicate?

A PEG ratio of 0.4 suggests that the company has a below-average P/E ratio with above-average growth, which might make it appear undervalued and worthy of further research.

How is the PEG ratio used as a benchmark within an industry?

The PEG ratio is used as a benchmark by comparing it to the industry average. If a company's PEG ratio is below the industry average, it may be considered a good investment candidate.

What historical rule of thumb is associated with the PEG ratio?

Historically, investors have used the rule of thumb to buy shares if the PEG ratio is below 1, hold shares if the PEG ratio is at 1, and sell shares if the PEG ratio is significantly above 1.

How can an increase in a company's share price affect its PEG ratio?

If a company's share price increases, its P/E ratio also increases, which can lead to an increase in the PEG ratio if the growth rate remains constant, potentially making the stock less attractive to investors.

What are some of the limitations of using the PEG ratio?

The PEG ratio does not account for negative earnings per share or growth rates, nor does it consider dividend payouts or free cash flow generation. It also requires choosing a specific time horizon for earnings and growth rate calculations.

Why might different websites show different PEG ratios for the same company?

Different websites may show different PEG ratios due to variations in the calculation methods, such as the choice of earnings per share (GAAP, continued operations, or adjusted) and the time horizon for growth rate (historical, rolling, expected, or a 5-year average).

What advice is given for investors who rely on PEG ratio data from websites?

Investors are advised to choose one single website for PEG ratio data to ensure comparability between companies, as different websites may use different calculation methods.