The price to earnings (P/E) ratio has been used by the investors in order to help value stocks for years. For calculating this the current price of the stock is divided by its earnings per share. In the 1990s, well-known investment manager Peter Lynch helped in popularizing an updated method of valuing stocks .
This newer method is referred to as the price to earnings to growth (PEG) ratio. In order to calculate the ratio, the price to earnings ratio is divided by the company’s estimated annual growth rate over the next few years.
From where to get annual growth estimate of a company?
The investor can obtain annual growth estimate of a company from online investment sites or a stockbroker. If a person has enough knowledge about the company, then he might be able to estimate the growth rate himself.
Lower the PEG ratio
The lower the PEG ratio is, the more the stock could be undervalued. Low PEG ratios are preferred by investors that are looking for value stocks. A PEG ratio of 1 is considered the baseline for analysis, and what it means is that the stock is valued fairly. A stock with a PEG ratio above 1 may be considered overvalued. It is indicated by a PEG ratio of below 1 indicates that the stock could be undervalued and may be a good buy for the investor.
Advantage of PEG ratio
One of the advantage of using the PEG ratio is that it adds future earnings potential to the historic P/E ratio equation. As a result, for valuing stocks with high growth potential the PEG ratio has more significance.
In evaluating the stock price of strong, established companies the PEG ratio may also be less relevant . These companies may not experience explosive growth, and may have PEG ratios higher than 1. When it comes to estimating the value of a stock purchase PEG ratios have both advantages and disadvantages . There is no foolproof method of determining that which stocks should be bought.
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