Price/Earnings-to-Growth Ratio (PEG Ratio)

Price/Earnings-to-Growth Ratio (PEG Ratio)

The Price/Earnings-to-Growth Ratio (PEG Ratio) is a valuation metric used to assess a Stock’s valuation by comparing its price-to-earnings (P/E) ratio to its earnings growth rate. It provides a more comprehensive view than the P/E ratio alone by factoring in expected growth, helping investors determine if a Stock is overvalued or undervalued based on its growth prospects.

Formula

PEG Ratio = (P/E Ratio) / (Annual EPS Growth Rate)

Interpretation

A PEG ratio of 1 is generally considered fair value, indicating that the Stock’s price is in line with its earnings growth expectations. A ratio below 1 may suggest that the Stock is undervalued, while a ratio above 1 may indicate overvaluation.

Examples

1. A company has a P/E ratio of 20 and an expected annual earnings growth rate of 10%. The PEG ratio would be calculated as:

PEG = 20 / 10 = 2.0

This suggests the Stock may be overvalued.

2. Another company has a P/E ratio of 15 and an expected annual earnings growth rate of 20%. The PEG ratio would be:

PEG = 15 / 20 = 0.75

This suggests the Stock may be undervalued.

Use Cases

Investors often use the PEG ratio in conjunction with other metrics to make informed decisions. For instance, a growth investor may look for Stocks with a PEG ratio under 1, indicating potential growth opportunities. Conversely, value investors might consider a higher PEG ratio if accompanied by strong fundamentals.