Apple Is a Better Deal Than Microsoft

CUPERTINO, Calif. (TheStreet) -- The price-to-earnings ratio is the Swiss army knife of financial analysis for value investors. They use it for everything. It forms the backbone of their investment decisions.

While this ratio is useful, it leaves something to be desired. A stock might seem expensive based on its P/E ratio, but its rapid growth might justify the high number. In these situations, the PEG (price/earnings to growth) ratio can help investors evaluate stocks with spotty earnings records and bright futures.

To calculate the PEG, divide a stock's P/E ratio by the earnings growth rate expected for the next five years. These numbers are available on TheStreet.com's stock-quote pages. Like the P/E ratio, a lower PEG number indicates a cheaper price. A stock with a PEG ratio of 1 is considered fairly priced. Larger values are more expensive; smaller ones are bargains.

High-growth companies are likely to have big P/E ratios because investors factor the value of potential gains into their stocks, bidding prices up beyond what's logical based on their P/E ratios. Amazon(AMZN) and Apple(AAPL) -- with P/E ratios of 55 and 32, respectively -- are good examples of these situations. Value investors might be inclined to exclude these names, but they would be wise to convert these numbers into PEG ratios before ruling them out.

Amazon is still very expensive based on its PEG ratio of 2.1. However, Apple's 1.38 ratio is close to those of other big technology stocks. IBM(IBM) has a slightly more attractive ratio of 1.21, while Microsoft(MSFT) and Dell(DELL) are a bit more expensive at 1.47 and 1.67, respectively.