PEG ratio stands for ‘Price Earnings to Growth’ ratio. To calculate the PEG ratio you just need to divide the P/E ratio by company’s growth. For example if the P/E ratio is 20 and the expected growth is 30% then PEG ratio becomes 20/30 = 0.66.
Now assume that P/E is 20 and expected growth is 20%. PEG ratio now becomes 20/20 = 1.
According to experts if PEG ratio is below 1 then it indicates that the stock is undervalued and one can buy it. In the first example of this post we got a PEG ratio of 0.66, it means that the stock is undervalued. In the second example we got a PEG ratio of 1. It means that the stock is fairly priced.
Now let us see an overvalued stock. Imagine the P/E ratio to be 20 and the growth rate is 15%. The PEG now is 20/15 = 1.33, as the value of PEG ratio is more than 1, we consider the stock to be overvalued.
Limitations of PEG ratio – The growth forecast can often be wrong as future growth can vary from the past performance. Some analysts therefore use average growth of past or the preceding period’s growth rate while calculating PEG ratio.
How to calculate PEG if P/E ratio isn’t available ? Almost all websites these days provide P/E ratio. But if you don’t find it, then here’s the formula
PEG ratio = (current share price / earnings per share) / (growth rate)
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