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When investing in stocks, the need to understand and use ratios is extremely important, especially when your focus is on fundamental stock analysis. The most common ratio is called the PE ratio, but there are several more, one of them is the PEG ratio.PEG is short for price/earnings to growth, and it’s a metric value that’s also kind of an extension of the PE ratio. You use the PEG ratio to calculate how much a stock is worth in comparison to a company’s growth rate, i.e. how fast the company is growing. One of the benefits of the PEG ratio is that it provides a more comprehensive value than some of the other ratios.
Similar to other ratios, the PEG ratio comes in handy when you want to compare two company stocks with each other to figure out which one, if any, is the best investment.
Calculate the PEG Ratio
The first step in calculating a PEG ratio is calculating the PE ratio. We have created a detailed guide about the PE ratio which we suggest you check out. However, for the sake of this article, we’ll offer a quick summary of how you calculate a PE ratio.
A PE ratio is determined by dividing a stock price with the earnings per stock (EPS) and as soon as you’ve done that you can continue with the rest of the PEG calculation.
In order to describe this in the best way possible, we will use an example and to make it as easy as possible we will continue with the example used in our PE guide. In that guide, we took a look at the Google stock and calculated that at the time Google’s PE was 55.6.
Next, we need to find Google’s growth rate. To do so, we compare the EPS from 2017 with the estimated EPS for 2018. According to Nasdaq, Google’s growth projection is 28.59 percent (see image below).
By dividing Google’s PE ratio (55.6) with the growth rate (28.59), we get 1.94 which means that Google’s PEG ratio for 2018 is 1.94.
PEG calculation
Let us summarize the calculation again. To figure out Google’s PEG ratio we need to start with finding the PE ratio, which in this case is 55.6. The second step is to calculate Google’s growth rate by comparing last year’s EPS with the projected EPS for this year. At the time of writing, Google had a projected growth rate of 28.59 percent. Finally, we divide the PE ratio with the growth rate to get the PEG ratio.
Are There Good and Bad PEG Ratios?
There would be no point in calculating a PEG ratio unless you knew how to use the data and how to apply that data to your analysis. Most people would agree that any PEG ratio below 1 is good, and any PEG ratio above 1 is bad.
This means that Google’s PEG ratio isn’t optimal and we might as well start looking for another stock with better potential. Just remember that there is more to a stock analysis than the PEG ratio and a high number is not always bad.
What Is the PEG Ratio Used For?
The idea is to use the information we just calculated to determine if a stock is over or undervalued in comparison to the company’s growth rate. Likewise, the PEG ratio can be used to estimate how long it will take to get your investment back.
The reason PEG ratios are preferred over many other ratios is that it provides a prediction that is more accurate than many other methods. You see, two companies could have the same PE ratio but not the same PEG ratio. That means that the companies look like they have the same investment potential when you only look at the PE, but as soon as you introduce the growth rate the differences become more clear.
Our point is that you shouldn’t put all your focus on one ratio but rather combine several in an attempt to paint a clearer picture of a stock’s potential.
Note that PEG and other ratios shouldn’t be used to compare companies from different industries since it diffuses the result. In other words, don’t try and compare the PEG ratio for a tech company like Amazon with a retail stock such as H&M. All industries work in different ways and are affected by different forces.
Other Ratios
In addition to the PEG ratio, there are several other ratios that can be useful to know about and understand before you start investing. We have written similar guides like this to a few other ratios which are listed below.
- PE ratio is the easiest and quickest ratio to calculate. It provides a good insight into whether a stock is under or overvalued, however, it’s not very accurate in all situations and should always be combined with other analytic methods. Also, the PE ratio is the foundation of the PEG ratio and if you haven’t read up about it yet you should.
- PS ratio is an interesting ratio that measures the value of a stock by focusing on the company’s ability to sell products and services. Sometimes this metric value is shortened to PSR, and you get it by dividing a company’s market cap by the yearly revenue. In combination with the PEG ratio, it provides a comprehensive projection about a stock’s potential as an investment.
A Conclusion of PEG Ratios
A PEG ratio is an extension of the commonly used PE ratio, and it’s used to analyze the value of a stock and its ability to grow over time. Calculating a PEG ratio for a stock is part of fundamental analysis which is something all investors ought to know how to do. The ratio is calculated by dividing a stock’s PE ratio with its growth rate. It’s really simple and all the needed information is provided by most stock graphs online.
As a last side note, we want to emphasize the importance of diversifying your analytic work and not only relying on one or even two ratios. The more analytic methods you use, the more your predictions will be more accurate.
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