Price/Earnings to Growth (PEG Ratio)
Definition of 'Price/Earnings to Growth (PEG Ratio)'
PEG Ratio stands for Price/Earnings to Growth, which is a means of determining the value of a stock in light of a company’s earnings growth. The PEG ratio is expressed as a percentage by dividing the stock’s price-to-earnings by its earnings per share growth.
TheStreet Explains ‘Price/Earnings to Growth (PEG Ratio)’
As an analytical tool, the PEG ratio is thought by many investors to be more realistic than simply looking at P/E ratios of a company (or multiple companies side by side) because it assigns a value to the expected growth in earnings. Yet, some analysts contend that a PEG ratio may not be the most appropriate tool to evaluate established companies in the same industry (since they may aim only for moderate or low growth), and that a PEG ratio can only be seen as an estimate (since it is predicated future growth). Caveats aside, the PEG ratio is widely employed by analysts and investors as an indicator in so far as the lower the ratio, the better (and less expensive) the investment is thought to be.
Valuation is a central part of investing; because common stocks represent claims on future earnings and because expected growth is an important factor in determining the intrinsic value of those stocks, the application of a PEG ratio to analysis is on the rise. A PEG ratio of 1 (derived from a company that has, for instance, a P/E ratio of 20 and an expected annual growth of 20%) represents a stock that is reasonably valued based on how much its company is believed to grow. A PEG ratio of 1 represents equilibrium between a stock’s market value and its expected earnings growth. If the ratio is greater than 1, it suggests that the market’s expectation of a company’s growth is higher than general estimates. It can also suggest that the stock is overvalued. A PEG ratio of less than 1 suggests that the market’s expectations of a company’s growth are lower than general estimates. It also suggests that the stock is undervalued.
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