PEG Ratio (Price/Earnings to Growth) Definition
The PEG Ratio is an enhancement of the PE ratio, used to help value a company.
The PEG (Price/Earnings to Growth) is a well-known ratio that is seen as an enhancement of the better-known PE ratio. Similar to the PE the PEG ratio is a metric useful in valuing a company, not only this the PEG also takes a company's growth rate into account.
The formula to determine PEG value of a company is derived as;
PE Ratio divided by EPS Growth
Where the PE (Price to Earnings) ratio is calculated as the Price per Share divided by Earnings per Share and the EPS growth is the growth percentage in EPS over the next year(s).
Companies with a PEG ratio value of 1 are seen to be of fair value, where the growth percentage and PE are perfectly aligned. A PEG of below 1 can make a company extremely favourable and be a sign its being undervalued. Although some would place a limit on how far below the PEG can fall below 1 before further investigation may be required. A PEG value above 1 in general would mean the company is being overvalued.
It is important to research a company carefully, the PEG although a wonderful ratio is said to work well only with company’s growing faster than usual for the industry/sector they are in. For a company that is years into maturity this ratio may not be quite as ideal for use. Figures used in the calculation of the PEG ratio also play a major part on valid results i.e. whether EPS growth percentages are based on historical or forecast values.
The PEG ratio acts as an excellent complimentary tool that should certainly be used with other metrics when evaluating a company.