PEG ratio – Price – Earnings to growth ratio

What is ‘Price / Earnings To Growth Ratio’ or ‘PEG ratio’?

PEG ratio or Price / Earnings To Growth Ratio is nothing but P/E ratio divided by growth ratio.  This ratio helps you to evaluate companies stocks by considering the growth into an account.

This ratio provides clear picture compared to P/E ratio, since it will consider growth.  It will suggest that a company is a good investment or not in terms of growth, with respect to the sector.  Majority of investors believes that companies with PEG ratio less than 1 is the good investment opportunity.

This can be helpful to evaluate the companies metric for relative trade-off between the price of the share, EPS and future growth.  It is straightforward way to evaluate a companies future growth.

Formula to calculate Price/Earnings To Growth Ratio

In order to calculate PEG ratio, one need to calculate P/E ratio first.  To calculate P/E, divide current market price of the share by earnings,  that is earnings per share (EPS).

P/E = Current market price of the share / EPS

(P / E) / G ratio = P/E ratio / Growth rate

Example

Consider a company with the following data, price of the share is 100, EPS this year = 10, EPS last year ₹8

P/E ratio = 100/10 = 10

Earnings growth rate = (10 / ₹8) – 1 = 25%

Now PEG ratio = 10/25 = 0.4

According to above calculations, this company has good PEG ratio, that is less than 1.  Therefore one can invest in this company,  but before that taking other ratios into consideration is far better.

Limitations

  • Fails to evaluate companies with less growth.
  • Growth rate is the estimation, projecting the  future growth. Growth of a company depends on various factors (Economic conditions, expansion setbacks).
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