The ins and outs of the price earnings growth (PEG) ratio

Fsp Invest, 20 Nov. 2013

Tags: peg, peg ratio, price earnings growth ratio, what is the peg, what is the peg ratio, how to calculate the peg ratio, investing, fundamental analysis, financial ratio,

The price earnings (PE) ratio is one of the most commonly used financial ratios. But, if a company’s PE starts to look on the high side, this can put some investors off as expectation are high for the company. So that’s where the price earnings growth (PEG) ratio comes in. Read on to discover the ins and outs of the price earnings growth (PEG) ratio…

The price earnings (PE) ratio is the current share price dividend by the earnings per share, Gareth Stokes in Fear, Greed and the Stock Market explains…

If you compare a company’s PE ratio to others in its sector, you can get an idea of whether a company is overpriced or undervalued.

But a high PE shouldn’t put you off. It’s not always a negative indicator.

Often a company has a high ratio because analysts expect earnings for the coming year to be really good. And the market has already factored such expectation into the price.

So to get over this hurdle, analysts created a new ratio called the price earnings growth (PEG) ratio. This ratio includes growth expectations.

How to calculate the PEG ratio

To calculate the PEG ratio, you need to do the following:

Simply take a company’s PE ratio and divide this by the earnings growth for the coming year.

PEG = (current share price/earnings per share)/expected earnings growth

Let’s run through an example…

Company ABC has a current PE of 20 times. Analysts expect that earnings will grow 50% over the coming year.

So to calculate the PEG, you divide the PE by the earnings growth (20/50). This gives you 0.4 times.

When you calculate PEG, the lower the PEG value, the better.

A PEG of 1 means the market’s effectively pricing in one year’s worth of future growth. So you want to find company’s where the PEG is less than 1 and the company achieves higher than expected growth in earnings per share.

High PEGs can indicate the market may be overpricing the profit growth the company is likely to achieve.

So there you have it, the ins and outs of the price earnings growth (PEG) ratio.

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