Price/Earnings to Growth ratio (PEG ratio) = (Price/earnings ratio) / Annual EPS growth
PEG ratio is widely used as an indicator of a stock's potential value. It is favored by many over the PE ratio because it also accounts for growth. Similar to the P/E ratio, a lower PEG means that the stock is more undervalued. Most will use 12-month trailing earnings for the bottom part of this formula.
What PEG ratio tells us
PEG ratio results greater than 1 suggest one of the following:-
- Market expectation of growth is higher than consensus estimates.
- Stock is currently overvalued due to heightened demand for shares.
PEG ratio results lower than 1 suggest one of the following:-
- Market expectation of growth is lower than consensus estimates.
- Stock is currently undervalued due to markets underestimating growth.
The PEG ratio is best suited to stocks with little or no dividend yield. Because the PEG ratio doesn't incorporate income received y the investor in its presentation of valuation, the metric may give unfairly inaccurate results for a stock that pays a high dividend. For companies paying out dividend, the PEG ratio calculation should be revised as following:-
PEG = (P/E) / (Growth estimate + dividend yield)
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