What Is PEG or Price-to-Earnings Growth?
Everyone wants a crystal ball when it comes to investing their money. But the reality is that making good predictions in investing is based on some basic math skills.
For those looking to make great investment choices, learning to identify the PEG ratio or the price-to-earnings growth ratio can provide insight into which stocks are worth buying for long-term payoff.
It also gives you an idea of the accuracy of the current valuation on a stock. When you watch the PEG ratio over time, you may see the ratio drop, signaling a good time to buy.
What To Know About the PEG Ratio
The price-to-earnings growth ratio is a measurement that compares the stock price, the earnings per share value and the rate of growth to give investors an idea of a stock’s value over time.
It can tell you if the stock price compares favorably to earning potential. It also shows you whether or not this potential is likely to continue based on growth rates projected by analysts.
How PEG Relates to P/E
To really understand PEG, get back to basics with the P/E ratio, or price-earnings ratio. This tells investors the ratio of the cost of shares to the earnings made by the company per share.
Divide the stock price by the earnings per share value to find the P/E ratio. A good P/E ratio is low, meaning the stock prices are valued reasonably. If the ratio is high, the stock prices are too high compared to earnings and it is not a good investment.
To calculate the PEG, you have to divide this P/E ratio by a rate of growth. It is preferable to the P/E ratio in many situations because the P/E ratio can only tell you the value of a stock today. The PEG ratio gives you a longer view.
What You Should Know About PEG Ratios
When you’re looking for undervalued stocks to buy in the dip, look for a PEG ratio under one. This means the price is staying low even in the face of growth and it is a good buy. A PEG above one means the price is likely too high compared to its growth.
Many new investors are scared of formulas and feel like they can’t understand the concepts behind stocks. Instead, they just want advice on what to buy today. But, by learning how to use some basic formulas to identify promising stocks, they can take more control of their investing.
Calcualting P/E ratio consists of finding out a particular company’s stock prices and its earnings per share number.
How To Calculate PEG Ratio
- Find the earnings per share.
- Subtract preferred dividends from net income.
- Divide this by the weighted average of shares outstanding: Earnings Per Share = (Income – Dividends) / Shares Outstanding.
- Slot this into the P/E ratio formula, which is simply the stock price divided by the earnings per share: P/E = Stock Value / Earnings Per Share
- To calculate the PEG ratio, divide the P/E ratio by the projected growth rate: PEG = P/E / Growth Rate
Using the Price-to-Earnings Growth Ratio
Now that you know what the price-to-earnings growth ratio actually is, you can apply it to your own work following investing trends. Spot undervalued stocks or stocks whose value has stayed good over a period of growth.
PEG ratios are projections based on guesstimates of investment analysts. Though they base their growth rate projection on facts, its projection of the future could be affected by many unforeseen events. Using a PEG ratio can give you a good idea about the future of a stock’s value, but remember that investing can involve a degree of risk.
Feeling confident in applying basic formulas to get more information about stocks can start you off on the right foot in investing. Learning how to find the earnings per share, P/E ratio and PEG ratio can give you insight into stocks that you would not have otherwise. Consult with the experts but learn how to calculate for yourself for hands-on investing.
PEG Ratio FAQHere are answers to some of the most frequently asked questions about PEG ratios.
- What is a good PEG ratio?
- A good PEG ratio is under one. Buying these low will bring better value over time than buying higher P/E ratios now.
- What does PEG indicate?
- The PEG ratio indicates the projected value of a stock over time based on its price-to-earnings ratio divided by its growth rate.
- What does a high PEG ratio mean?
- A high ratio -- a ratio over one -- may mean that a stock is overvalued. You would be paying too much in price compared to the potential earnings on the stock.
- How can a company have a negative P/E ratio?
- While calculating PEG ratios, you may find a company that has a negative P/E ratio, which means the stock company has not made earnings over the last year.This does not immediately mean the stock is a poor investment. Get more information about how long earnings have been down and if there is a temporary cause for it.
- Why is the PEG ratio negative?
- A PEG ratio may be negative if the stock company's P/E ratio is negative due to losses or if analysts have assigned a negative growth rate to the company.A negative PEG ratio is troubling if the P/E ratio has been negative due to long-term losses or growth has slowed because of insurmountable challenges to the business. More information would be needed before investing.
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- Corporate Finance Institute. "Earnings Per Share Formula - Examples, How to Calculate EPS."
- Stock Analysis. 2020. "What Does a Negative PE Ratio Mean for Stocks?"