Know what PEG ratio is!

The degree to which a result of the PEG ratio indicates an overpricing or underpricing stock varies according to industry and by company type.

PEG ratio is a company’s price/earnings ratio divided by its earnings growth rate over a period of time. The PEG ratio adjusts the traditional P/E ratio by considering the growth rate in the earnings per share that are expected in the future. It is considered to provide a more complete picture than the more standard P/E ratio.   

How to calculate the PEG ratio?  

PEG ratio = (Price/EPS)/EPS growth 

Where, EPS = Earnings per share   

To calculate the PEG ratio, an investor or analyst needs to calculate the P/E ratio of the company. The P/E ratio is calculated as the price per share of the company divided by the earnings per share (EPS), or price per share/EPS. After the calculation of PE, factor the expected growth rate into the above equation.   

A low P/E ratio may indicate that the stock is a good bet to buy but factoring in the company's growth rate to get the stock's PEG ratio may tell a different story. The stock can be identified as more undervalued if the PEG ratio is lower, given its future earnings expectations. Adding the company's expected growth into the ratio helps to adjust the result for companies that may have a high growth rate and a high P/E ratio.  

In the words of Peter Lynch, a famous financial and value investor, a PEG ratio of 1 portrays equilibrium. The equilibrium is between the recognised value of a stock's worth and its earning potential.  

The degree to which a result of the PEG ratio indicates an overpricing or underpricing stock varies according to industry and by company type. On an overall basis, investors are more inclined toward a PEG ratio that results below one.