Pension Obligation Bonds
Pension funds across the world are facing a significant financial crisis. This is because, for a very long time, they have been investing heavily in equities since the interest rates offered by debt funds were quite low. However, in the recent past, the equity markets have sharply declined. As a result, the asset values of […]
Pros and Cons of Going Public
The decision to take a company public is a huge one. When a company gets listed on an exchange, it joins an elite list of institutions that have done so creating a positive reputation. However, listing on the exchange is about a lot more than reputation. There are a lot of tangible benefits that accrue […]
Multiproduct Contribution Margin
Finding the Contribution Margin: It begins with the same old way. Companies have to compute the contribution margin for each of their products. This is a possibility if a company has a couple of hundred products. If there are thousands of products, we may have to use the sales based approach mentioned in the end […]
Is this the Longest Bull Market in History?
The news media has been full of claims that the present market is the longest bull market in history. Media reports have claimed that the bull market which began on March 9, 2009, has lasted for close to 3500 days. This Bull Run seems to have surpassed the previous Bull Run which began after the […]
Infrastructure Finance Projects: Major Sources of Funding
It is a known fact that the world is in great need of infrastructure projects and, therefore, infrastructure finance. Developing countries need to build their infrastructure for the first time. This needs to be done in order to attract more investments. However, even developed countries need to build more infrastructure projects. This is because the […]
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.
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
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.
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.
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