PEG ratio

The PEG ratio (Price/Earnings To Growth ratio) is a valuation metric for determining the relative tradeoff between the price of a stock, the earnings generated per share (EPS), and the company's expected growth.
In general, the P/E ratio is higher for a company with a higher growth rate. Thus using just the P/E ratio would make highgrowth companies appear overvalued relative to others. It is assumed that by dividing the P/E ratio by the earnings growth rate, the resulting ratio is better for comparing companies with different growth rates.^{[1]}
The PEG ratio is considered to be a convenient approximation. It was popularized by Peter Lynch, who wrote in his 1989 book One Up on Wall Street that "The P/E ratio of any company that's fairly priced will equal its growth rate", i.e., a fairly valued company will have its PEG equal to 1.
Contents
Basic formula
The growth rate is expressed as a percentage above 100%, and should use real growth only, to correct for inflation. E.g. if a company is growing at 30% a year, and has a P/E of 30, it would have a PEG of 1.
A lower ratio is "better" (cheaper) and a higher ratio is "worse" (expensive).
The P/E ratio used in the calculation may be projected or trailing, and the annual growth rate may be the expected growth rate for the next year or the next five years.
Examples:
 Yahoo! Finance uses 5year expected growth rate and an averaged P/E for calculating PEG (PEG for IBM is 1.26 on Aug 9, 2008 [1]).
 The NASDAQ website uses the forecast growth rate (based on the consensus of professional analysts) and forecast earnings over the next 12 months. (PEG for IBM is 1.148 on Aug 9, 2008 [2]).
PEG as an indicator
PEG is a widely employed indicator of a stock's possible true value. Similar to PE ratios, a lower PEG means that the stock is undervalued more. It is favoured by many over the price/earnings ratio because it also accounts for growth.
The PEG ratio of 1 is sometimes said to represent a fair tradeoff between the values of cost and the values of growth, indicating that a stock is reasonably valued given the expected growth. A crude analysis suggests that companies with PEG values between 0 to 1 may provide higher returns.^{[2]} The PEG Ratio can also be a negative number, for example, when earnings are expected to decline.This may be a bad signal, but not necessarily so. Under many circumstances a company will not grow earnings while its free cash flow improves substantially. Here, as in other cases, analyzing the components of PEG becomes paramount to a successful investment strategy.
The PEG ratio is commonly used and provided by various sources of financial and stock information. The PEG ratio, despite its wide use, is only a rule of thumb and has no accepted underlying mathematical basis. Its specific mathematical deficiency is explained here.
The PEG ratio's validity at extremes in particular (when used, for example, with lowgrowth companies) is highly questionable. It is generally only applied to socalled growth companies (those growing earnings significantly faster than the market).
When the PEG is quoted in public sources it may not be clear whether the earnings used in calculating the PEG is the past year's EPS or the expected future year's EPS; it is considered preferable to use the expected future growth rate.
It also appears that unrealistically high future growth rates (often as much as 5 years out, reduced to an annual rate) are sometimes used. The key is that management's expectations of future growth rates can be set arbitrarily high; this is a selfserving ploy where the objectives are to keep themselves in office and to make the stock artificially attractive to investors. A prospective investor would probably be wise to check out the reasonableness of the future growth rate by checking to see exactly how much the most recent quarter's earnings have grown, as a percentage, over the same quarter one year ago. Dividing this number into the future P/E ratio can give a decidedly different and perhaps a more realistic PEG ratio.
Advantages
Investors may prefer the PEG ratio because it explicitly puts a value on the expected growth in earnings of a company. The PEG ratio can offer a suggestion of whether a company's high P/E ratio reflects an excessively high stock price or is a reflection of promising growth prospects for the company.
Disadvantages
The PEG ratio is less appropriate for measuring companies without high growth. Large, wellestablished companies, for instance, may offer dependable dividend income, but little opportunity for growth.
A company's growth rate is an estimate. It is subject to the limitations of projecting future events. Future growth of a company can change due to any number of factors: market conditions, expansion setbacks, and hype of investors. Also, the convention that "PEG=1" is appropriate is somewhat arbitrary and considered a ruleofthumb metric.
The simplicity and convenience of calculating PEG leaves out several important variables. First, the absolute company growth rate used in the PEG does not account for the overall growth rate of the economy, and hence an investor must compare a stock's PEG to average PEG's across its industry and the entire economy to get any accurate sense of how competitive a stock is for investment. A low (attractive) PEG in times of high growth in the entire economy may not be particularly impressive when compared to other stocks, and vice versa for high PEG's in periods of slow growth or recession.
In addition, company growth rates that are much higher than the economy's growth rate are unstable and vulnerable to any problems the company may face that would prevent it from keeping its current rate. Therefore, a higherPEG stock with a steady, sustainable growth rate (compared to the economy's growth) can often be a more attractive investment than a lowPEG stock that may happen to just be on a shortterm growth "streak". A sustained higherthaneconomy growth rate over the years usually indicates a highly profitable company, but can also indicate a scam, especially if the growth is a flat percentage no matter how the rest of the economy fluctuates (as was the case for several years for returns in Bernie Madoff's Ponzi scheme).
Finally, the volatility of highly speculative and risky stocks, which have low price/earnings ratios due to their very low price, is also not corrected for in PEG calculations. These stocks may have low PEG's due to a very low shortterm (~1 year) PE ratio (e.g. 100% growth rate from $1 to $2 /stock) that does not indicate any guarantee of maintaining future growth or even solvency.
References
 ^ Easton, Peter D. (January 2002), Does The Peg Ratio Rank Stocks According To The Market's Expected Rate Of Return On Equity Capital?, http://papers.ssrn.com/sol3/papers.cfm?abstract_id=301837^{[dead link]}
 ^ Khattab, Joseph (April 6, 2006), How Useful Is the PEG Ratio?, The Motley Fool, http://www.fool.com/investing/value/2006/04/06/howusefulisthepegratio.aspx, retrieved November 21, 2010
External links
Categories: Financial ratios
Wikimedia Foundation. 2010.
Look at other dictionaries:
PEG Ratio — See: prospective earnings growth ratio * * * The price/earnings growth ratio is calculated by dividing a stock s prospective price/earnings ratio (PER) by the rate of estimated future growth in earnings per share (EPS). The higher the PEG… … Financial and business terms
Price/Earnings To Growth  PEG Ratio — A ratio used to determine a stock s value while taking into account earnings growth. The calculation is as follows: PEG is a widely used indicator of a stock s potential value. It is favored by many over the price/earnings ratio because it also… … Investment dictionary
PEG — or Peg may refer to: Contents 1 See also Devices Clothes peg Tent peg Tuning peg, on a musical instrument Piton, in climbing Part of a flatland BMX bicycle Science, medicince and compu … Wikipedia
PEG коээфициент — PEG коэффициент (англ. PEG ratio, Prospective Earnings Growth Ratio) финансовый коэффициент сопоставляющий цену акции с прибылью на акцию и ожидаемой будущей прибылью компании. PEG коэффициент был разработан для коррекции недостатков коэффициента … Википедия
PEG коэффициент — (англ. PEG ratio, Prospective Earnings Growth Ratio) финансовый коэффициент сопоставляющий цену акции с прибылью на акцию и ожидаемой будущей прибылью компании. PEG коэффициент был разработан для коррекции недостатков коэффициента… … Википедия
PEG (finanzas) — El ratio PEG (Price/Earnings To Growth, es decir, Precio/Beneficio a Crecimiento), es una medición que relaciona el valor de mercado de una acción, los beneficios por acción (BPA, EPS en inglés) y el crecimiento futuro esperado de la compañía. Se … Wikipedia Español
PEG Payback Period — A key ratio that is used to determine the time it would take for an investor to double their money in a stock investment. The price to earnings growth payback period is the time it would take for a company s earnings to equal the stock price paid … Investment dictionary
PEG — ist die Abkürzung für: Flughafen Perugia im IATA Flughafencode Paul Ehrlich Gesellschaft für Chemotherapie e.V. PCI Express for Graphics, eine Computer Schnittstelle für Grafikkarten ein auslaufendes Kfz Kennzeichen des ehemaligen Landkreises… … Deutsch Wikipedia
Ratio financiero — Saltar a navegación, búsqueda Los Ratios Financieros, son coeficientes o razones que proporcionan unidades contables y financieras de medida y comparación, a través de las cuales, la relación (por división) entre sí de dos datos financieros… … Wikipedia Español
Ratio financiera — Este artículo o sección sobre economía necesita ser wikificado con un formato acorde a las convenciones de estilo. Por favor, edítalo para que las cumpla. Mientras tanto, no elimines este aviso puesto el 27 de julio de 2007. También puedes ayudar … Wikipedia Español