PEG Ratio Formula Example Calculation Analysis & Use Explanation

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Unlike the PE ratio , the PEG ratio does account for some of a company’s growth prospects. All else equal, a company growing quicker should have a higher PE ratio than a slow-grower. The PEG ratio helps normalize companies for earnings growth (or show undervalued stocks which wouldn’t show up through other screens).

A company that’s expected to grow its revenue, earnings and cash flow at a high rate is, all other things being equal, more valuable than a company with little growth opportunity. There is one major difference between these two companies , which is that Fast Co is growing its earnings per share at a much faster rate than Slow Co. Given how quickly Fast Co is growing, it seems reasonable to pay more for the stock. One way of estimating how much more, is by divided each company’s PE ratio by its growth rate.

The PEG (or P/E-to-growth) ratio looks at a company’s share price relative to its earnings per share and projected earnings growth rate. By factoring in a company’s future growth, some analysts see the PEG ratio as giving a more complete view of a stock’s value, particularly for fast-growing companies. The PEG ratio is a company’s Price/Earnings ratio divided by its earnings growth rate over a period of time (typically the next 1-3 years). The PEG ratio adjusts the traditional P/E ratio by taking into account the growth rate in earnings per share that are expected in the future.

The PEG ratio measures the relationship between the price/earnings ratio and earnings growth to provide investors with a more complete story than the P/E alone. The P/E is typically calculated by measuring historical earnings or trailing earnings. Unfortunately, historical earnings are not of much use to investors because they reveal little about future earnings, which is what investors are most interested in determining. The first is to use a company’s earnings from the past year, commonly referred to as TTM, for trailing twelve months. The advantage of this approach is that it doesn’t require an estimate.

What is a PEG Ratio?

As with any ratio, the accuracy of the PEG ratio depends on the inputs used. When considering a company’s PEG ratio from a published source, it’s important to find out which growth rate was used in the calculation. In an article from Morgan Stanley Wealth Management, for example, the PEG ratio is calculated using a P/E ratio based on current-year data and a five-year expected growth rate. An investor taking just a cursory glance could easily conclude that this is an overvalued stock. The high yield and low P/E make for an attractive stock to a conservative investor focused on generating income.

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Understanding The PEG Ratio

Some people use another method, in which the stock’s trailing PEG ratio is reported, calculated by using trailing growth rates. The trailing growth rate could be derived from the last fiscal year, the previous 12 months, or some sort of multiple-year historical average. Turning again to the stock in our example, if the company had grown earnings at 20% per year for the past five years, you could use that number in the calculation, and the stock’s PEG would be 0.8 .

However, no single ratio can tell investors all they need to know about a stock. It is important to use a variety of ratios to arrive at a complete picture of a company’s financial health and its stock valuation. There are numerous examples of scenarios where the P/Es of stocks in a particular industry are expected to rise. Banks, for example, earn more income as interest rates rise since they can charge higher rates on their credit products such as credit cards and mortgages. Basic materials and energy companies also receive a boost to earnings from inflation since they can charge higher prices for the commodities they harvest. Information provided on Forbes Advisor is for educational purposes only.

Based on our calculated ratio of 1.5x, the company would be deemed overvalued since it exceeds 1.0x. This metric can provide a much more informed view of a stock in relation to its earning potential. The PEG ratio is considered to be an indicator of a stock’s true value, and similar to the P/E ratio, a lower PEG may indicate that a stock is undervalued. Timothy Li is a consultant, accountant, and finance manager with an MBA from USC and over 15 years of corporate finance experience.

INVESTMENT BANKING RESOURCESLearn the foundation of Investment banking, financial modeling, valuations and more. The dividend payout ratio is the measure of dividends paid out to shareholders relative to the company’s net income. The PEG ratio provides useful information to compare companies and see which stock might be the better choice for an investor’s needs, as follows. Differences will depend on which growth estimate is used in the calculation, such as one-year or three-year projected growth.

Unlike the traditional price-to-earnings ratio (P/E), which tends to be used more frequently among investors, the PEG ratio accounts for the future growth of the company. Using the PEG ratio formula can be useful, but ultimately financial modeling is the best way to account for all aspects of a company’s growth profile when performing a valuation. Building a Discounted Cash Flow model typically takes into account about 5 years of forecasted growth, plus a terminal value, to arrive at the net present value of the business. To compute a PEG ratio, you need to first decide which number you will plug into the formula.

Price to Earnings/Growth Ratio Formula

A PEG ratio acts as a factor that determines how accurately a company decides on the price at which its stocks should be traded. It is a ratio within a ratio as users have to find out the price/earnings ratio first to see how it relates to a company’s expected growth. Accordingly, the the stocks of the companies that are expected to have a better market value, increased cash flow, and enhanced future potential, trade at a higher rate. Price/earnings to growth ratio, or PEG ratio in short, is a measure that compares the company’s stock price with its earnings and expected growth rates. It can be interpreted as the price that investors are willing to pay for $1 of earnings given 1% of the expected growth rate.

However, when the aspect of a projected growth rate is factored in, it might tip the scales. Estimations present an EPS growth rate of 18% for stock A, while for stock B it is 30%. Estimations concerning a company’s growth rate can stretch across different periods. However, the higher the number of years, the more there is a chance of inaccuracy in results. As mentioned previously, it denotes the ratio between a stock’s P/E ratio and its projected growth in earnings.

This would represent the theoretical equilibrium between the market value of a stock and its anticipated earnings growth. For example, a stock with an earnings multiple of 20 and 20% anticipated earnings growth would have a PEG ratio of one. The PEG ratio, which measures a stock’s price-to-earnings to growth, can be a helpful tool when researching value stocks. The calculation of the ratio involves usage of estimated growth rate. Since the ratio is based on estimations, it is subjected to the possibility of major deviations from the actual results.

This helps to check whether it is in line with their past performance. They should also factor in considerations like change in business conditions, breakthroughs by a company, etc. PEGY ratio is a variation of the PEG ratio where a stock’s value is evaluated by its projected earnings growth rate and dividend yield.

Any P/E ratio needs to be considered against the backdrop of the P/E for the company’s industry. The PEG ratio is arguably a more meaningful measure of value than the P/E ratio alone. By factoring in growth, the PEG ratio helps an investor evaluate a company’s price in relation to its future earnings growth potential.

How to Calculate PEG Ratio (Step-by-Step)

how to calculate peg ratio per share is the amount of a company’s profit allocated to each outstanding share of a company’s common stock, serving as an indicator of the company’s financial health. In other words, earnings per share is the portion of a company’s net income that would be earned per share if all the profits were paid out to its shareholders. EPS is used typically by analysts and traders to establish the financial strength of a company.

• But things are not always so straightforward when it comes to determining which growth rate should be used in the calculation.
• The market expectation of growth is higher than consensus estimates.
• Therefore, inferences should always be in the context of industry, company type, etc.
• As with any ratio, the accuracy of the PEG ratio depends on the inputs used.
• An investor taking just a cursory glance could easily conclude that this is an overvalued stock.

Thorough and thoughtful stock research should involve a solid understanding of the business operations and financials of the underlying company. The PEG ratio tells you how expensive a stock is relative to its growth rate. The price-to-earnings ratio is the most widely ratio used by investors, but the PEG has a key advantage over the PE ratio in that it adjusts the P/E for growth.

One trick is to modify the PEG ratio by adding the dividend yield to the estimated growth rate during calculations. Even though these two fictional companies have very different valuations and growth rates, the PEG ratio allows us to make an apples-to-apples comparison of the relative valuations. It is a mathematical way of asking whether a specific stock or a broad industry is more or less expensive than a broad market index, such as the S&P 500 or the Nasdaq.

This makes the PEG ratio more of a fluid variable and one that is best used in ranges as opposed to absolutes. Let’s take an example to understand the calculation in a better manner. Suzanne Frey, an executive at Alphabet, is a member of The Motley Fool’s board of directors. The Motley Fool has positions in and recommends Alphabet and Alphabet .

Analysts conclude that the company has an anticipated earnings growth of 40% over the next five years. Estimated future earnings, which reflects expectations for growth, is also an important metric for stock assessment. A share is currently trading at $30 and the EPS of the share is $2.