What is a "PEG Ratio"?

If you have been using a site such as Yahoo! Finance or Google Finance to check up on your favorite stock, then you may have run across something called the "PEG Ratio".

What is the "PEG Ratio" of a stock? The "PEG Ratio" is similar to a P/E calculation (Price to Earnings) in that it tries to determine whether a stock is undervalued or overvalued.

What differentiates the "PEG Ratio" from a typical Price to Earnings calculation is that the "PEG Ratio" also accounts for earnings growth, while the P/E calculation does not.

The "PEG Ratio" translates into Price/Earnings to Growth. To calculate a stock's "PEG Ratio", you take the price of the stock and divide it by annual earnings (per share). You are left with the P/E Ratio, or Price to Earnings ratio.

Then, you divide this number by Annual EPS Growth. Annual EPS Growth is represented as a whole number, meaning that if annual EPS (Earnings per Share) growth is 15%, then your Annual EPS Growth number for the calculation would be 15.

So let's take a stock called XYZ. The stock is currently trading at $100 per share, has current EPS (Earnings per Share) of $5.00 and is growing at 10% per year.

To calculate the "PEG Ratio", you would:

Divide 100 (Share Price) by 5 (Annual EPS). This would give you 20, which would represent the company's P/E Ratio.

Next, you would divide 20 by 10 (annual growth rate), which would leave you with 2. This would give the company a "PEG Ratio" of 2, which is considered to be quite high.

To calculate a company's Annual EPS Growth, you can look at their historical numbers and try to determine how fast the company is growing, and apply these numbers towards future quarters. Or you can read how fast the analysts covering the stock think that a company will grow, and plug these numbers into your calculations. There are many ways of trying to determine what the EPS growth for a company is. There is no one right way to do this.

A company with a "PEG Ratio" of 1 or lower is generally considered to be a "good investment", where a company over 1 is considered to be a bit more pricey. A "PEG Ratio" is just one way of trying to determine whether or not a company is a good buy - you can not use it alone to determine value, or you will probably end up losing a lot of money. It's just another tool in your arsenal to use.

Filed under: Stock Market Education | General Knowledge