A ratio to help you uncover shares that could multiply your money many times over

Julie Brownlee, Fsp Invest, 12 May. 2014

Tags: ratio, shares, peg ratio, peg, price earnings growth ratio, stocks, how to find bargain stocks, how to find growth stocks, calculating peg

If you could uncover shares in companies that were small, growing and profitable, you could be onto the next big thing. So how can you find shares like this? According to renowned investor Jim Slater, you can find this out by using the price earnings to growth ratio (PEG ratio). Let’s take a closer look at how this works…

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Try to unearth a bargain with the PEG ratio

When you come across a share that looks like it has great potential, how can you see if it’s a bargain or not? You use the PEG ratio.

For example, you find a share with a price earnings (PE) ratio of 30. The higher a PE, the higher the market’s expectation that the company will grow quickly, Tim Bennett in Money Week explains.

But with a high PE, how do you know if the company is cheap or not. Slater thinks it all comes down to comparing the PE with the rate the company’s earnings are growing. This is the PEG ratio.

If profits rose 20%, the PEG would be as follows:

PEG = 30/20 = 1.67.

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Using the PEG ratio to find ‘cheap’ stocks

This PEG suggests that the company isn’t cheap. Fans of the PEG ratio believe that the earnings growth rate should match the PE. For instance, a company on a PE of 20 should grow earnings at 20%.

So if you’re looking for a bargain, you need to find a company with a PEG ratio of less than 1.

For example, say a company is growing its earnings 20% a year. It’s trading on a PE of 15. Its PEG is 0.75 (15/20). This makes the company look like a bargain as the growth rate is higher than what the PE suggests it should be.

To calculate a company’s PEG, you can get the PE ratio and earnings growth from many financial websites, such as Bloomberg. Bloomberg provides a PEG ratio too.

So there you have it, a ratio to help you uncover shares that could multiply your money many times over.

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