Popularized by the legendary Peter Lynch, It’s a ratio that will
help you look at future earnings growth 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 20 and projected earning growth next year of 10% would have a PEG of 20 / 10 = 2.
If you have a stock with a low P/E. Since the
stock is has a low P/E, you start to 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 find that answer, PEG ratio will help. 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.
