Price/Earnings To Growth - PEG Ratio
What is the 'Price/Earnings To Growth - PEG Ratio'
The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period.
The PEG ratio is used to determine a stock's value while taking the company's earnings growth into account, and is considered to provide a more complete picture than the P/E ratio.
BREAKING DOWN 'Price/Earnings To Growth - PEG Ratio'
While a low P/E ratio may make a stock look like a good buy, factoring in the company's growth rate to get the stock's PEG ratio can tell a different story.
The lower the PEG ratio, the more the stock may be undervalued given its earnings performance.
The degree to which a PEG ratio value indicates an over or underpriced stock varies by industry and by company type, though a broad rule of thumb is that a PEG ratio below one is desirable.
Also, the accuracy of the PEG ratio depends on the inputs used.
Using historical growth rates, for example, may provide an inaccurate PEG ratio if future growth rates are expected to deviate from historical growth rates.
To distinguish between calculation methods using future growth and historical growth, the terms "forward PEG" and "trailing PEG" are sometimes used.
Below we show you the three companies with the highest and lowest PEG ratios in the S&P 500. This information is updated daily so be sure to return or visit our Markets page to keep updated on various companies and decide which stocks to add to your Watchlist or even invest in.
Highest PEG Stocks in the S&P 500
| Add | Symbol | PEG | Price |
|---|---|---|---|
Lowest PEG Stocks in the S&P 500
| Add | Symbol | PEG | Price |
|---|---|---|---|
PEG Ratio Calculation Examples
To calculate the PEG ratio, and investor or analyst needs to first calculate the P/E ratio of the company in question.
The P/E ratio is calculated as the price per share of the company divided by the earnings per share (EPS):
P/E ratio = Price per share / EPS
Once the P/E is calculated, the PEG ratio's formula is simply:
PEG ratio = P/E ratio / earnings growth rate
Assume the following data for two hypothetical companies, Company A and Company B:
Company A price per share = $46
Company A EPS this year = $2.09
Company A EPS last year = $1.74
Company B price per share = $80
Company B EPS this year = $2.67
Company B EPS last year = $1.78
Given this information, the following data can be calculated for each company:
Company A P/E ratio = $46 / $2.09 = 22
Company A earnings growth rate = ($2.09 / $1.74) - 1 = 20%
Company A PEG ratio = 22 / 20 = 1.1
Company B P/E ratio = $80 / $2.67 = 30
Company B earnings growth rate = ($2.67 / $1.78) - 1 = 50%
Company B PEG ratio = 30 / 50 = 0.6
Many investors may look at Company A and find it more attractive since it has the lower P/E between the two companies.
But compared to Company B, it doesn't have a high enough growth rate to justify its P/E.
Company B is trading at a discount to its growth rate and investors purchasing it are paying less per unit of earnings growth.
Get more acquainted with the PEG ratio by reading PEG Ratio Nails Down Value Stocks and How To Find P/E And PEG Ratios.
Read more: Price/Earnings To Growth (PEG Ratio) https://www.investopedia.com/terms/p/pegratio.asp#ixzz5GexsSZn9
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When computing the PEG ratio for a stock, how is a company's earnings growth rate determined?
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A:
Remember that the price/earnings to growth ratio (PEG ratio) is simply a given stock's price/earnings ratio (P/E ratio) divided by its percentage growth rate. The resulting number expresses how expensive a stock's price is relative to its earnings performance.
For example, let's say you're analyzing a stock trading with a P/E ratio of 16. Suppose the company's earnings per share (EPS) have been and will continue to grow at 15% per year. By taking the P/E ratio (16) and dividing it by the growth rate (15), the PEG ratio is computed to be 1.07. But things are not always so straightforward when it comes to determining which growth rate should be used in the calculation. Suppose instead that your stock had grown earnings at 20% per year in the last few years, but was widely expected to grow earnings at only 10% per year for the foreseeable future. To compute a PEG ratio, you need to first decide which number you will plug into the formula. You could take the future expected growth rate (10%), the historical growth rate (20%) or any kind of average of the two.
Let's explain the two methods that are commonly used. The first is to use a forward-looking growth rate for a company. This number would be an annualized growth rate (i.e. percentage earnings growth per year), usually covering a period of up to five years. Using this method, if the stock in our example was expected to grow future earnings at 10% per year, its forward PEG ratio would be 1.6 (16 divided by 10). You might also see people using another method, in which the stock's trailing PEG ratio is reported, calculated by using trailinggrowth 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, we could use that number in the calculation, and the stock's PEG would be 0.8 (16 divided 20).
Neither one of these approaches to PEG ratio calculation is wrong - the different methods simply provide different information. Investors are often concerned about what price they are paying for a stock relative to what it should earn in the future, so forward growth rates are often used. However, trailing PEG ratios can also be useful to investors, and they avoid the issue of estimation in the growth rate since historical growth rates are hard facts.
Regardless of what type of growth rate you use in your PEG ratios, what matters most is that you apply the same method to all the stocks you look at, to ensure that your comparisons are accurate. You should also bear in mind that PEG ratios will vary by industry and company type, so there is no universal standard for PEG ratios that determines whether a stock is under- or overpriced. Generally speaking, however, a PEG ratio of less than 1 suggests a good investment, while a ratio over 1 suggests less of a good deal. Remember, PEG ratios don't tell you anything about the future prospects of a company (i.e. a company sure to go bankrupt will likely have a very low PEG ratio, but that doesn't mean it's a good investment).
For further reading, check out Move Over P/E, Make Way For The PEG and How The PEG Ratio Can Help Investors.
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