PEG ratio
The equation for PEG looks like this. PEG= (P/E ratio)/ (Earnings growth) You simply divide the P/E by the percentage you are expecting the company's earnings to grow. For example if you have a company with a PE of 40 and the company’s earnings grow an average of 20% annually the equation would look like this. PEG= 40/20 or 2. In this case the Price to earnings ratio would equal 2. The lower the PEG ratio is the better it is said to be. A stock with a PEG of .7 is considered a better buy then a stock with a PEG of 2. 1 is also said to be the magic number for this study. If the PEG is at 1 it is suppose to be at a fair market value. If it is over 1 it is overvalued, and of course if it is less than 1 it is undervalued or cheap. Because this takes into consideration future growth many people believe it is more accurate then P/E which is only focused on the here and now. The downside of this ratio is that you are assuming something will happen but it hasn’t actually happened yet. If you overestimate how fast the company will grow the company will look like a better investment. If you underestimate how fast a company will grow it will look like a worse investment. This study can work against you as a trader. If you are expecting a company’s earnings to increase 35% but they only increase 16% it could have been disadvantageous to use it. Because of this the PEG should never been token as a standalone indicator.
Other Ratios Here are some other financial ratios. PE ratio - Another way to tell if a stock’s price is undervalued using earnings. Price to Sales Ratio – Looks at the price of the company compared to its sells. Solvency Ratio - A way to tell how likely it is that a company will meet its long term obligations |
