Fundamentals Analysis - PEG Ratio - Price Per Earnings Per Growth

Hi,

This is the second in a series of fundamentals analysis ratios.  This post is about the PEG ratio, which is gives us an insight into how expensive a share in a company is, given their expected growth.  

This ratio is useful because it takes into account an extra piece of information, growth, or future potential to give us an indicator of value.  One thing that we may do with the information is also perform analysis on the company to find out if their projected growth is realistic.  If it seems to be, then this could well be a good company.

The PEG ratio = (Share Price / Earnings Per Share) / Annual Earnings Per Share Growth.

See also PE Ratio

Due to the fact that the growth part of the ratio is projected, this is a speculative value, and therefore can be less accurate.  If you use this ratio in conjuction with other ratios and they all tell the same story, this should give you a good idea as to where the company is heading.

The value of the PEG ratio, if a lower number is obtained, the stock could be seen as cheaper.  The higher the ratio, the more expensive the stock is.

A value of 1 is generally accepted as a reasonable trade-off between stock cost and the expected growth of the company.  A value of 2 or higher would generally be seen as expensive, relative to the amount of growth that is expected for the company.

This ratio is less appropriate for valuing the price of a share for a company that does not expect future growth, and instead expects dividend income.  The use of the ratio in this case is down to what you are looking for in a stock purchase.