PEG Ratio

Financial reports include an item called PEG ratio in addition to other important indicators like price to earnings. If you’re an investor who's interested in growth opportunities, you'll want to look at PEG ratio. This indicator measures the price to earnings ratio of a stock as compared to the earnings growth of the company.

Here is the way its calculated. This is the ratio of the Price to Earnings (P/E) to the annual earnings growth rate:

PEG = P/E ratio / Annual earnings growth rate

If the P/E is 32 and the annual growth rate is 21%, the PEG is:

PEG = 32 / 21 = 1.52

P/E doesn’t always take place in a vacuum-if the earnings growth rate is close to the P/E ratio (so that PEG is close to 1) the stock could be an attractive buy-its priced high but earnings are growing-so it may go higher in the future. So if a hypothetical company had a P/E of 22 and an annual earnings growth rate of 11%, its PEG would be:

PEG = 22/11 = 2.0

That’s not such a good sign. Earnings are not growing to compensate for the high P/E ratio, so the price of the stock may be heading down.

On the other hand if a company had a high P/E ratio of 30 but a high growth rate of 25%, the PEG is:

PEG = 30/25 = 1.2

That’s a much better indicator of a good stock. If the PEG is less than or equal to 1, you are looking at a really good situation. Let's look at some technology stocks. As of December 2009, the following four technology stocks all have excellent values:

- IBM : 0.97- Apple: 1.33- Google: 1.08- Garmin: 1.3

(note these values are subject to change). Value investors will not be as interested in price to earnings growth as they are P/E, but if you're looking to growth-its a good thing to check out. Often P/E can be high for a reason-because the earnings of the company are expected to grow dramatically in the coming months.

PEG Ratio Lecture from NYU Business School

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