PEG Ratio

Price Earning Growth Ratio takes the concept of Price / Earning Ratio (P/E Ratio) and adds in the element of Growth in it.

The P/E Ratio is calculated by dividing Price of the Share with its Earning Per Share. So, if Google has a market price of 423.30 and an EPS of 13.68, its P/E Multiple will be: 424.84 / 13.68 = 31.06.

To calculate the Price Earning Growth Ratio or PEG Ratio, you need to take the P/E Ratio and divide it by the growth in the EPS. You can take an estimate of future earnings growth or an average of the past earnings growth.  There is no hard and fast rule of which growth rate you should take. But, I think it’s best to be conservative and take the one which is the least growth rate you could find.

Suppose, for Google you find that this growth rate is 15%, your PEG Ratio will be: 31.06 / 15 = 2.07.

The conventional wisdom is that a PEG of greater than 1 indicates an overvalued company, and less than 1 indicates an undervalued company. There is really no good way of finding out what growth number you should take. You could go to Yahoo Finance and look at the analyst estimates or look at what the company does, and see what different growth numbers result in.

This is an easy metric to calculate, but because it depends on future projections, you should be a little wary of how you use it.

Here are a couple of useful articles about PEG Ratio. The first one explains the positives of the PEG Ratio and the second one explains the negatives.

How useful is the PEG Ratio?

Dismantling the PEG Ratio

I think it is a ratio, along with many others, and should be looked in conjunction with other numbers like free cash-flow, debt – equity, dividend payout etc. It’s a good thing to be aware of, but not something that you should completely rely on.

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