PEG Ratio

The price/earnings (P/E) ratio divided by expected per-share earnings growth over the coming year. A value of less than 1 implies that the stock may well be undervalued; more than 1 implies that it is overvalued.

The idea behind the PEG Ratio is to relate price to growth, given that some expectations about growth -- or the lack thereof -- are built into every P/E. PEG is considered particularly helpful in valuing small and mid-cap growth stocks, which typically pay no dividend. For valuing larger stocks, Peter Lynch adds a company's dividend yield to its projected five year earnings growth rate on the theory that larger, more established firms are valued by investors for their current payout as well as the prospect of price appreciation.

PEG ratios are considered less useful in assessing cyclical stocks and those in industries such as banking, oil or real estate, where assets are a more important indicator of value.

 

 

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