MSG Team's other articles

11967 Why Does the Stock Market Crash?

February 2018 has been a bad month for the United States stock market. In just two consecutive trading days, the market crashed by more than 1500 points. As a result, all the incremental gains that were made in January 2018 were simply wiped out within these two days. It would be incorrect to say that […]

11436 The Stripe Business Model

Stripe is one of the most prominent start-ups in the world. It does not have the fame or popularity of other start-ups like Uber or Airbnb. However, Stripe has achieved an equivalent amount of success. In fact, as of early $2022, this start-up company was valued at $95 billion! This stupendous valuation makes it one […]

9675 How Team Performance Affects Valuation?

Sporting franchises are often said to be confused about what their objectives should be. One chain of thought believes that since they are businesses, their objectives should also be financial in nature. This means that their objectives should also be about profit maximization or wealth maximization. On the other hand, there is a different chain […]

10189 What is Litigation Funding?, Its Advantages and Disadvantages

Legal costs have long been a deterrent for people wanting to file lawsuits. In a country like America, the legal fees can be significant. A lot of good lawyers charge hourly fees. Many plaintiffs believe that in an hourly fee system, the lawyer is incentivized to drag the case for as long as possible. This […]

9538 Hire Purchase Agreements

Buying Assets on Installments A hire purchase agreement is a particular type of agreement between a buyer and seller. The asset being sold in this case is generally a fixed asset. Also, the amount that has to be paid, is not paid in one single payment. Rather the payment is done in instalments over a […]

Search with tags

  • No tags available.

The Price Earnings Growth (PEG) Ratio is one of the first variations that were made to the Price to Earnings Ratio to make it more meaningful. The full form of the PEG Ratio is Price Earnings Growth ratio.

Instead of being a two way comparison between price and earnings, the PEG ratio makes a three way comparison. The first step is to arrive at the price to earnings ratio whereas the next step is to divide this ratio by the growth rate of the company to arrive at the PEG ratio.

The PEG ratio was developed because investors argued that current stock market price is an expectation of future gains to be made by the company in question. Therefore valuing it solely on the basis of the current year’s earnings is incorrect. They realized that two companies could currently have the same earnings but the one that has been growing its earnings faster needs a better valuation. It is for this reason that they started factoring in growth rates before concluding whether the company is fairly prices.

Formula

PEG Ratio = Price to Earnings Ratio / Growth Rate

The growth rate is calculated based on historic data. Analysts could use as much data as they feel is comfortable without losing the current trend of earnings of the company in question.

This growth rate is usually expected as a percentage out of 100. For example, if a company has a growth rate of 20% and a P/E Ratio of 30. Then the PEG Ratio will be:

PEG Ratio = 30/20 = 1.5

Assumptions

  • Growth Rate Expected to Continue: The PEG Ratio is an extension on the P/E Ratio and therefore makes some of the audacious assumptions that the P/E Ratio makes as well.

    The PEG Ratio assumes that the current rate of growth of the company is expected to continue. However, in reality trends usually last for 4 to 5 years. So by the time the analyst does figure out the trend, it would be affected by the cyclical nature of business and may have changed.

Interpretation

  • Fairly Priced Will Equal Growth Rate: Veteran investors place a lot of faith in the PEG ratio. They believe that in the long term, the P/E ratio of the company will always equal its growth rate.

    Therefore if the PEG ratio is equal to 1, then the company is fairly priced. This means that investors must actively scout for companies with PEG ratios less than 1.

Article Written by

MSG Team

An insightful writer passionate about sharing expertise, trends, and tips, dedicated to inspiring and informing readers through engaging and thoughtful content.

Leave a reply

Your email address will not be published. Required fields are marked *

Related Articles

What are Common Size Statements ?

MSG Team

Cash Ratio – Meaning, Formula and Assumptions

MSG Team