The price/earnings to growth ratio (PEG ratio) is a stock's price-to-earnings (P/E) ratio divided by the growth rate of its earnings for a specified time period. The PEG ratio is used to determine a stock's value while also factoring in the company's expected earnings growth, and it is thought to provide a more complete picture than the more standard P/E ratio.
KEY TAKEAWAYS
The PEG ratio enhances the P/E ratio by adding in expected earnings growth into the calculation.
The PEG ratio is considered to be an indicator of a stock's true value, and similar to the P/E ratio, a lower PEG may indicate that a stock is undervalued.
The PEG for a given company may differ significantly from one reported source to another, depending on which growth estimate is used in the calculation, such as one-year or three-year projected growth.
What Does the Price/Earnings-to-Growth Ratio Tell You?
While a low P/E ratio may make a stock look like a good buy, factoring in the company's growth rate to get the stock's PEG ratio may tell a different story. The lower the PEG ratio, the more the stock may be undervalued given its future earnings expectations. Adding a company's expected growth into the ratio helps to adjust the result for companies that may have a high growth rate and a high P/E ratio.
The degree to which a PEG ratio result indicates an over or underpriced stock varies by industry and by company type. As a broad rule of thumb, some investors feel that a PEG ratio below one is desirable.
According to well-known investor Peter Lynch, a company's P/E and expected growth should be equal, which denotes a fairly valued company and supports a PEG ratio of 1.0. When a company's PEG exceeds 1.0, it's considered overvalued while a stock with a PEG of less than 1.0 is considered undervalued
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