The ideal PEG ratio is a financial ratio that is used to compute a company’s expected growth. It is calculated by taking the price per earnings ratio and dividing it by the earnings growth rate over one to three years. The PEG ratio is the P/E ratio adjusted to take into account the growth rate in earnings per share (EPS) anticipated in the future. joe lusardi It provides a complete picture of the stock’s value versus standard P/E ratios.
A company anticipates growing its earnings, cash flow, and revenue at a higher rate than a company with fewer opportunities to grow. rounding top reversal pattern Value companies often have lower P/E ratios than growth companies. For these reasons, investors are ready to pay more for future growth. High near-term valuations do not necessarily pose a problem when investors see the growth potential.
How much then are investors willing to pay for growth? Using the change at any cost approach can lead one to overspend on a great company. diagonal call However, the PEG ratio can help an investor decide the price on a company’s growth rate.
PEG Ratio Calculations
the company’s P/E ratio by the anticipated growth rate. What is needed to calculate the PEG ratio:
Earnings per share
Expected earnings growth
The PEG ratio is calculated by dividing
The trailing P/E ratio is used for the calculation of the PEG ratio.
PEG Ratio Formula
PEG = Price to Earnings Ratio / Earnings Growth Rate
Let’s look at the following example.
A company has a P/E ratio of 18 and a expected earnings growth rate of 12% per year. The PEG ratio will be:
PEG = 18/12 = 1.5
Because the company’s PEG ratio is more than one, many investors would shy away from this investment. The growth rate in the denominator is treated as a general number and not as a percentage.
A stretch through different periods can be used in the estimations of a company’s growth rate. The period could be between 1-3 years. However, the chances of the result being inaccurate increase as the number of years increases.
Investors can refer to the company’s declared estimates to get the growth estimates. They can also employ the use of projections published on analysts’ websites.