PEG ratio explained

What is the PEG ratio? The PEG ratio is an investing rule of thumb that has been around for decades. The aim is to use the price earnings growth ratio to try to find growth at a reasonable price.

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0:00 What is the PEG ratio
0:15 Calculating the P/E ratio
1:18 PEG ratio calculation
1:45 PEG ratio interpretation
2:33 Using the PEG ratio to buy and sell stocks
3:18 PEG ratio example
3:39 PEG ratio limitations
4:00 Which EPS and growth number
5:02 How to find PEG ratio data

In order to calculate the PEG ratio, we start off with calculating the P/E or price-earnings ratio. The P/E ratio is calculated by dividing a company’s share price by an accounting metric called earnings per share. P/E ratios are commonly quoted and widely used. For a company with a $50 share price, and $5 EPS, the price-earnings ratio is 10. The price-earnings ratio shows how much investors are willing to pay per dollar of earnings. How many years does it take to cover the price, if earnings stay the same.

Well, guess what: earnings probably won’t stay the same. Incorporating the growth rate into the picture adds some dynamics into the fairly static P/E ratio. PEG takes the #PEratio one step further. If the company’s current EPS is $5, while it was $4 in the prior year, then they realized an EPS growth rate of 25% over the past year.

This is what you need to calculate the price-earnings-growth ratio: take the P/E ratio that we calculated, and divide it by the growth rate. P/E of 10, divided by growth rate of 25, gives you a PEG ratio of 0.4. In the PEG ratio calculation, the growth rate is adjusted from a percentage basis to a whole number basis.

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