Investor Education - What's the PEG Ratio ?
InvestorEducation / Investing Nov 27, 2006 - 01:42 PM GMTBy: Shahla_Walayat
The Market Oracle is starting off a series of educational articles with the Price Earnings Growth (PEG) Ratio. The PEG ratio compares a companies price/earnings (PE) ratio to its expected Earnings per share (EPS) growth rate
Taking Google as an example
- Share Price $505
- This years EPS is $10.3 (est 2006), divided by NEXT years earnings estimate is 13.7 which represents a 33% growth in earnings (13.7/10.3).
- Therefore the Peg ratio is calculated as
- PE = 505 /10.3 = 49
- Peg Ratio = 49/33% = 1.48
This would suggest that Google is learning towards being expensive, which supports recent MarketOracle analysis on Google.
(Also note many sources suggest comparing this years earnings to last years, that is WRONG, to arrive at the PEG you should compare NEXT years earnings to this years).
How to use the Peg Ratio ?
If the Peg ratio is greater than 1, then this usually suggests that the stock is overvalued as the market is expecting faster future growth. On the other hand if the Peg Ratio is less than 1 then this suggests that the stock is undervalued.
Therefore In general, the lower the PEG ratio, the better the value, because the investor would be paying less for each unit of earnings growth.
- <0.5 =Strong Buy
- 0.5 to 1 = Buy
- 1.0 to 1.25 = Hold
- 1.25 to 2 = Over valued
- 2+ = SELL
PEG ratio's should not be used in isolation to other indicators, such as price charts, and compare to the Peg ratio of similar stocks i.e. picking the cheapest stock in the best sector. Also note that growth stocks tend to have PE ratios >1.
Many sources of market data readily calculate the Peg ratio and provide extensive FREE financial information on stocks such http://www.ADVFN.com
, (under the
company information tab), some of which we will cover in future articles. Remember the PEG ratios is P/E divided by Expected growth (Next year EPS/Cur year EPS).
For now go through your portfolio, create an excel spreadsheet and list the the PEG ratio for each stock and see if they are under or overvalued. How have they performed relative to their market sector ? The peg should give a clue on performance. Also look for stocks that have low PEGs for further analysis. Again the PEG is not to be used on its own.
Shahla Walayat
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