PEG (Price to future growth ratio!) and what it tells you!

The market is usually more concerned about the future than the present, it is always looking for some way to figure out what is going to happen in the companies future.

A ratio that will help you look at future earnings growth is called the PEG ratio.

You calculate the PEG by taking the P/E and dividing it by the projected growth in earnings.

PEG = (P/E) / (projected growth in earnings)

For example, a stock with a P/E of 30 and projected earning growth next year of 15% would have a PEG of 30 / 15 = 2.

What does the “2” mean?

Technically speaking: The lower the PEG number, the less you pay for each unit of future earnings growth. So even a stock with a high P/E, but high projected earning growth may be a good value.

So, to put it very simply, we are interested in stocks with a low PEG value.

Just for the sake of understanding, consider this situation, you have a stock with a low P/E. Since the stock is has a low P/E, you start do wonder why the stock has a low P/E. Is it that the stock market does not like the stock? Or is it that the stock market has overlooked a stock that is actually fundamentally very strong and of good value?

To figure this out, you look at the PEG ratio. Now, if the PEG ratio is big (or close to the P/E ratio), you can understand that this is probably because the “projected growth earnings” are low. This is the kind of stock that the stock market thinks is of not much value.

On the other hand, if the PEG ratio is small (or very small as compared to the P/E ratio, then you know that it is a valuable stock) you know that the projected earnings must be high. You know that this is the kind of fundamentally strong stock that the market has overlooked for some reason.