Individual Stocks

Price / Earnings Ratios and Other Calculations

What is a “price/earnings to growth ratio”?

We use the PEG ratio to delve deeper into understanding the potential growth hidden within a company’s price/earnings ratio of a company. Since it is generally thought that an analysis of a P/E ratio alone would make fast-growing companies appear overvalued or overpriced when compared with others, the PEG ratio is a slightly better measure, especially when comparing companies with different rates of growth. Companies with lower PEG ratios tend to be more undervalued. If a stock has a PEG ratio of 1, it is thought to be fairly priced. We are paying the right price for the stock and the growth in the company’s earnings. Some experts believe that in extreme cases, when comparisons are being made by extremely fast-growing companies, the PEG ratio becomes less valid. Also, many experts are unclear about what numbers are being used to compute the PEG (whether or not the analysts are using trailing 12-month earnings reports, or near-term future expected earnings to compute the growth rate), so it may be difficult to rely upon a company’s published PEG ratio alone. Some experts believe it is often preferable to use expected (future) earnings growth rates, but not too far into the future, as it makes the underlying data less reliable. To compute the PEG ratio, divide a stock’s P/E by its annual earnings per share growth rate. The lower the ratio, the cheaper the stock, and vice versa.


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