PEG Ratio

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 What is PEG Ratio?

The Price-to-Earnings Growth (PEG) ratio is a financial metric that helps assess the value of a company's stock relative to its earnings growth rate. It is used to evaluate if a stock is overvalued or undervalued by comparing its price-to-earnings (P/E) ratio to the company's growth rate.

Here's how to calculate the PEG ratio:

Formula:


PEG Ratio = P/E RatioAnnual Earnings Growth Rate 


Step-by-step process:

  1. Find the P/E Ratio:

    • The P/E ratio is calculated by dividing the market price per share by the earnings per share (EPS).
    P/E Ratio = Market Price per ShareEarnings per Share (EPS)

    You can find this value from financial reports or stock market data.


  2. Obtain the Annual Earnings Growth Rate:

    • The annual earnings growth rate is the rate at which a company's earnings are expected to grow over a specific period (typically the next 5 years). This can be found in analysts' projections or financial reports.


  3. Calculate the PEG Ratio:

    • Once you have both the P/E ratio and the earnings growth rate, you can calculate the PEG ratio by dividing the P/E by the earnings growth rate.

Example:

Let’s assume the following:

  • P/E ratio of a company = 20
  • Expected annual earnings growth rate = 10%

Now calculate the PEG ratio:

PEG = 2010 = 2


Interpretation:

  • A PEG ratio of 1 is considered "fairly valued" (the stock is trading at a fair value relative to its growth rate).
  • A PEG ratio below 1 suggests the stock may be undervalued (the stock may be priced lower relative to its growth).
  • A PEG ratio above 1 suggests the stock may be overvalued (the stock may be priced higher relative to its growth).



Important Notes:

  • The PEG ratio assumes that earnings growth will continue at a constant rate, which may not always be the case.
  • The PEG ratio is particularly useful for comparing companies in the same industry.