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Price Earnings to Growth

Price/Earnings to Growth also known as the PEG, is a type of financial ratio that is used to determine the value of a stock while taking into account the growth rate of the company’s earnings.

In other words it can be defined as a financial valuation metric that is used to determine the tradeoff between the stock, EPS and the expected company’s growth. It acts like a measure that takes future growth into account.

With the help of this metric, speculators and investors gauge whether high growth stocks are undervalued or overvalued.

How to Interpret the PEG Ratio?

The P/E ratio is high for a firm with a high growth rate, and low for a firm with a low growth rate. However, using only the price to earnings ratio will make high growth companies look overvalued as compared to other. But by dividing this ratio by the growth earnings rate, the ratio offers a better result for comparing different firms, and their growth rate.

While a low PE ratio may show that stock is a good option to buy, after factoring in the growth rate of a company to determine the stock’s price/earnings to growth ratio; it can reflect an entirely different story. The rule of thumb for interpreting PEG ratio is that, price/earnings to growth ratio below 1 is desirable. The price/earnings to growth ratio of one is said to characterize a fair tradeoff between the growth values and the cost values. It indicates that the stock is realistically valued given the growth rate expected. PEG ratio values between 0 to 1 shows that the company may offer high returns.

PEG Ratio- The Basic Formula

The formula for computing price/earnings to growth is:

The rate of growth in this formula is stated as a percentage which is divided by 100 percent. Please note to correct ratio findings for inflation it is advisable to use the real growth.

For calculation accuracy, inputs used are extremely important. For example, using historical (past) growth rates may offer inaccurate price/earnings to growth ratio if growth rates in the future are expected to diverge from previous growth rates.

To distinguish calculation methods that are used for future and historical growth, terms like trailing PEG and Forward PEG are used.


Further Reading


The articulation of price-earnings ratios and market-to-book ratios and the evaluation of growth
www.jstor.org [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

The magic in earnings: Economic earnings versus accounting earningsThe magic in earnings: Economic earnings versus accounting earnings
www.tandfonline.com [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

What determines price-earnings ratios?What determines price-earnings ratios?
www.tandfonline.com [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

The information content of price-earnings ratiosThe information content of price-earnings ratios
www.jstor.org [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

Factors affecting price earnings ratios and market values of Japanese firmsFactors affecting price earnings ratios and market values of Japanese firms
www.jstor.org [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

Fundamental determinants of the Australian price–earnings multipleFundamental determinants of the Australian price–earnings multiple
www.sciencedirect.com [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

Do price-earnings ratios drive stock values?Do price-earnings ratios drive stock values?
jpm.pm-research.com [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …

Price-earnings regressions in the presence of prices leading earnings: Earnings level versus change specifications and alternative deflatorsPrice-earnings regressions in the presence of prices leading earnings: Earnings level versus change specifications and alternative deflators
www.sciencedirect.com [PDF]
… the summary num- ber in the income statement and P/B prices the summary … These are derived from standard formulations of price in terms of accounting numbers, in … First, the competing transitory earnings and earnings growth interpretations of the PIE ratio are reconciled and …



Q&A About Price Earnings to Growth


What do you use to determine how much a company will grow in a year?

You can use analyst estimates, historical data, and future projections to determine how much a company will grow in a year.

How can you calculate a PE ratio?

You can calculate a PE ratio by dividing market price by earnings per share.

Is there anything else you should consider when calculating this metric?

Yes, inflation must be considered when calculating this metric because real growth rates should be used for accurate results.

How is the PEG ratio calculated?

The PEG ratio is calculated by dividing the PE Ratio by the expected growth rate.

What does the PEG ratio measure?

The PEG ratio measures the value of a stock while taking into account its growth rate.

Are there any other metrics similar to this one that investors can use instead of using this formula alone ?

Yes, another metric similar to this one is called price earnings yield which involves dividing the current share price by next years estimated earnings per share (EPS). This gives an idea about what return on investment (ROI) an investor might get from buying shares today versus waiting until next year to purchase them at their lower price due to EPS increases during that time period .

What are some examples of high growth companies that have low PE ratios?

Amazon, Netflix, Tesla Motors Inc., and Facebook are all examples of high growth companies with low PE ratios.

Why would someone use this formula to calculate a company's value?

Someone might use this formula to calculate a company's value because it is easy to understand and quick to compute. It also provides an estimate that can be used in comparison with similar companies or with historical values. This formula also allows investors who do not have access to detailed financial statements to get an idea of what they should pay for shares in that company. However, there are many problems associated with using this formula as an accurate way of valuing stocks including that it does not take into account cash flow from operations or changes in debt levels over time which may affect stock prices more than net income alone; nor does it consider growth rates or expected future profitability when computing valuation ratios such as price-to-earnings ratios (P/Es) and price–book value ratios (P/Bs). As well, if new capital has been issued then market capitalization will be different from book value which could lead one to incorrectly conclude that shares are undervalued if they trade at less than book value but actually trade at less than book value because too much new capital was issued relative to assets owned. Another problem is that some companies pay out all their earnings as dividends so their P/E will always be greater than one even though

What does the PE ratio represent?

The PE ratio represents how much you are paying for each dollar of earnings.

What are some other names for the PE Ratio?

Some other names for the PE Ratio include P/E, PER, and Price-to-Earnings Ratio (PE).

What is the PE ratio?

The PE ratio is the price of a share divided by earnings per share.

What does it mean if your PEG ratio is below 1 or above 1?

If your PEG ratio is below one then it means that your stock may offer high returns. If your PEG ratio is above one then it means that your stock may be overvalued given its expected growth rate.