The PEG Ratio
In the last section you learned what the PE ratio is and how to use it. Now it’s important to know what the PEG ratio can do for you. The Price Earnings to Growth Ratio (PEG) is an extension of the Price Earnings ratio. It just relates the PE ratio to the growth per year of the stock. In other words or mathematically:
PEG = PE/Earnings Growth per year
Let’s take numbers again in order to make the whole matter more comprehensive.
Stock X price is currently at 15$ and the earnings per stock is at 1.2$. Thus, we get a PE ratio of 12.5 (15/1.2).
We continue by looking to the earnings per stock one year ago. There stock X had earnings of only 1$. So, its earnings rose by 20% (1.2/1).
To calculate the PEG ratio we simply have to divide 12.5 over 20%. In this case we get the number 0.625.
Very easy, but what does this number reveal? Generally, every stock with a PEG ratio under 1.00 is regarded as undervalued, whereas everything above 1.00 states an overvaluation. Therefore, based on this valuation alone you should buy stocks with PEG ratios under 1.00 and sell those above 1.00. But to determine the worthiness of a stock taking this figure alone is of course not satisfactory. Not only fundamental but also technical information on a stock is needed. The latter will be discussed in later chapters.
Be cautious when calculating the PEG ratio, only take, if possible, the earnings growth of the last five years. Only looking at the current growth rate could tamper the whole ratio.
You can get free info on the PE and PEG ratio on Yahoo Finance under the category “key statistics” on the left column.
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