Price earning to growth ratio
PEG ratio is a more advanced ratio and uses the PE ratio and expected annual EPS growth. The only ratio that considers future growth is the PEG ratio. All other ratio’s only look at the past.
How to use PEG ratio
- Lower is better.
- A PEG ratio above 2 is considered overpriced.
- Can be very different between industries.
- Can be used to compare companies.
|0.5||You can buy the stock cheap based on future growth|
|1||You pay a fair price based on future growth|
|2||The stock is overpriced based on future growth|
Why do investors use PEG ratio in their analysis
The PEG ratio tells investors if a stock has a fair price, is cheap or is overpriced based on its future earnings. If the PEG ratio is low that might be an opportunity to look further in the details of .
The three steps every investor should look at:
- What is the current PEG ratio?
- How does it compare to the industry?
- What is the trend?
Things to be aware of
- Only compare with other companies in the same industry.
- It’s based on future predictions which may not come true at all.
- Always check how many years are used for predicting future earnings. Some sites/screeners use a one year forecast and others use multiple years.
- PEG ratio is unreliable if the forecast is based on many years in the future.
- In general (when looking at historic data) a business can only maintain a 5-10% growth over many years.
- Other sites might use different settings (TTM vs YOY) or longer time periods. You should not compare PEG ratios to different websites unless the calculation is exactly the same.
How to calculate PEG ratio
Real life example
Real life example of Tesla. You need the following data to determine the PEG ratio:
The EPS is calculated as follows:
EPS = net income \ outstanding shares.
The net income can be found on the income statement (make sure you select yearly in the top). Also, make sure you always look at net income applicable to common shares. This means that preffered dividends on stocks are deducted:
The amount of outstanding shares can be found on the balance sheet report:
- Year 2020: $690,000 / 3,465,000 = 0.19 EPS
- Year 2021: $5,519,000 / 3,465,000 = 1.59 EPS
To calculate the expected annual EPS growth:
- (EPS latest year / EPS year before) - 1
- (1.59 / 0.19) - 1 = 730%
The average growth from 2020 to 2021 was 730%. To calculate the PEG ratio:
- PEG ratio = PE ratio / expected annual EPS growth
- 717 / 730 = 0.98
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