PEG Ratio (Price/Earnings to Growth Ratio)

The PEG ratio (Price/Earnings to Growth ratio) is a valuation metric that compares a stock’s price-to-earnings (P/E) ratio to its expected earnings growth rate. It is calculated by dividing the P/E ratio by the annual earnings growth rate. A PEG ratio of 1 suggests that a stock’s price is fairly valued relative to its growth rate, while a PEG ratio below 1 may indicate an undervalued stock. The PEG ratio provides a more complete picture than the P/E ratio alone, as it considers a company’s growth potential.

Example

A stock with a P/E ratio of 20 and an expected earnings growth rate of 10% has a PEG ratio of 2, indicating it may be overvalued relative to its growth.

Key points

• Measures a stock’s valuation by comparing its P/E ratio to its expected growth rate.

• A PEG ratio of 1 suggests fair valuation; below 1 may indicate undervaluation.

• Offers a more comprehensive view than the P/E ratio by factoring in growth.

Quick Answers to Curious Questions

Why is the PEG ratio preferred over the P/E ratio for growth stocks?

The PEG ratio accounts for a stock’s growth potential, providing a more balanced view of valuation for companies with high growth rates.

What does a PEG ratio below 1 indicate?

A PEG ratio below 1 suggests that the stock may be undervalued relative to its earnings growth, potentially offering an investment opportunity.

How can investors use the PEG ratio to assess stocks?

Investors use it to identify stocks that are undervalued or overvalued based on their earnings growth, helping in making more informed investment decisions.