PEG Ratio – For Evaluating the stock price in the share market, one must know about the concept of PEG ratio. PEG stands for Price-to-earnings-to-growth ratio. People who are already involved in the stock market knew about this concept. For people who are beginners or thinking to start investing in the stock market, that concept is very helpful.
Generally, the P/E (price-to-earnings) ratio is used for evaluating the stock price. But the PEG ratio is now an advanced form of P/E ratio for evaluating the stock price for entry. That is one of the initial steps in the fundamental analysis of the stocks.
The PEG ratio is a form of PE ratio which helps investors to know how much the market is willing to pay for every rupee in the company’s earnings.
Like the P/E ratio gives information that the stock price is overvalued or undervalued, the same PEG works. To know more about the P/E ratio, click to read stock quotes (part 2).
If P/E is higher, that means investors are optimistic about future growth.
If P/E is lesser, that means investors are pessimistic about the company’s future growth.
Benjamin Graham taught us PE=15 or less is better for evaluating the stocks. But what about those companies where PE is more than 15 but are better to invest in?
I have seen a lot of companies whose PE is on the higher side & the investors are willing to buy those stocks.
Another term is EPS that stands for earnings per share. It means when the company makes its profit, divides it into its shareholders. Generally, the company divides its profit into two categories:
Category- 1, that they keep themselves for further expansion.
Category- 2, which they divide into shareholders in the form of dividends.
Suppose there are two companies X & Y.
X has 4nos. of shareholders & Y has 5nos. of shareholders. Both companies are generating 1lac profit.
Their EPS as follows:
Net Profit – 1,00,000; Shareholder – 4; EPS – 25,000
Net Profit – 1,00,000; Shareholder – 5; EPS – 20,000
Both companies are generating the same profit but having different EPS value. The company whose shareholders are less have more EPS value. And the company whose shareholders are more has low EPS.
More EPS is better for the company and, they can provide more dividend value compare with low EPS company.
PEG Ratio Formula
For calculating the PEG ratio, P/E and EPS have its role. The companies, whose EPS are more than 15 can be evaluated with the PEG Ratio.
It can be calculated as:
PEG = Price to Earnings / EPS growth Rate.
Understand the below example of Dr. Reddy’s Laboratory.
The EPS growth rate can be calculated with the help of the Compounded Annual Growth Rate concept (CAGR).
How to read the PEG ratio?
PEG < 1, when the PEG value is less than 1, it is better. When the PEG ratio is less than 1, the price of the stock is undervalued. At this point, the share price is not justifiable. Sooner or later, the share price will move up till it reaches a PEG ratio become 1.
PEG = 1, when the PEG value is equal to 1, it means the share price is justified with its growth rate. At this level. There is an equal chance the price of the stock will go up or go down.
PEG > 1, when the PEG value is more than 1, it means the price of the stock is overvalued. At this level, the price of the stock will rarely move up. Sooner or later, the price of the stock will eventually move down. At this point, the share price is not justifiable with its growth rate.
When you evaluate the company, you must evaluate the same sector, only then you can find the correct growth rate.
The results come from the PEG ratio can only give you an idea that which company you should evaluate further for long-term investing.
Below is the list of the companies, to evaluate further based on the PEG Ratio.
Forget all the stocks in the list and just focus on the companies who are undervalued & evaluate further their fundamentals & Economic Moat concept.
- PEG ratio has a limitation in measuring the companies with low growth.
- It is difficult to evaluate the blue-chip companies because it already reached the saturation point of growth.
- Not able to evaluate whose P/E ratio is not available, or the EPS growth rate is going down.