What is PEG Ratio? How to Use PEG Ratio?

Brandie E Blackler
10 Min read

So far in your investment journey, have you heard of the PEG ratio? Do you know how to use the PEG ratio when analysing potential investment decisions? 

There are multiple indicators and metrics available for investors to value a stock’s potential worth. The price/earnings to growth ratio (or PEG ratio, for short), is one of them.

As its name suggests, the PEG ratio takes into account the stock price and the company’s earnings per share, plus its growth rate. 

In this article, we will go through the basics of the PEG ratio, and how you can use it in your own investing and trading activity at Admirals. 

What is PEG Ratio: An Introduction 

Most of the traditional and older metrics, such as the price-earnings ratio (P/E ratio), do not take into account an important indicator: the company’s expected growth. The PEG ratio makes up for this shortcoming by adding the growth ratio into the equation. That said, all metrics come with pros and cons which should always be considered. 

A company’s PEG ratio is calculated by dividing its P/E ratio by the company’s expected growth ratio (EGR), as shown in the formula below: 

PEG = P/EEGR 

A company’s P/E ratio should be relatively accessible to obtain and calculate since the numbers can be easily found online. However, the company’s EGR is a different story: how exactly are you supposed to put a company’s potential growth into numbers? 

The fact is that there isn’t a set formula to determine a company’s growth rate - it’s all based on estimates.

Brokers, financial websites and stock market indexes can have different growth rates for the same company, all based on their own criteria and formulas. Choosing which EGR to use in order to calculate a company’s PEG is up to the investor. 

Naturally, the PEG ratio can be used to determine whether to invest in a specific stock. 

Would you like to learn more about trading, investing and the financial markets with our free webinars? Click the banner below to register for an upcoming webinar today: 

Free trading webinars

Tune into live webinars hosted by our trading experts

What is a Good PEG Ratio for a Stock? 

As mentioned earlier, the PEG ratio can be used as an investment metric.

In order to calculate a company’s PEG ratio, you first need to collect all the necessary data.

You will need to find the company’s stock price and its earnings per share. Then, you will have to decide on which growth rate to use.

Choosing one from a reliable source, such as your online broker or direct bank, is a potentially reliable option. 

Once you have all the numbers ready, it’s time to calculate the company’s PEG ratio. There is a rule of thumb for PEG ratio-oriented investments: 

  • If the PEG ratio is 1, then the stock is considered fairly valued. 
  • Stocks with a PEG ratio between 0 and 1 are considered undervalued. 
  • When the PEG ratio is higher than 1, then the stock is considered overvalued. 

Undervalued stocks should be more desirable than overvalued stocks, but that isn’t always going to be the case.

Keep in mind that bigger companies will usually have less potential for growth and lower growth rates compared to newer, less established companies. Context is important: a high PEG ratio doesn’t necessarily equal a bad investment. 

PEG Ratio and P/E Ratio: How Do They Compare? 

Both the PEG ratio and the P/E ratio use the stock price and the earnings per share for reference.

Likewise, both ratios can be used to determine a stock’s value. However, there are some fundamental differences between these two ratios. 

The P/E ratio is a popular option among value investors for several reasons.

First of all, it’s reasonably easy to calculate, since it only requires the stock price and the EPS - which are both fairly simple to find (online).

The P/E ratio also lets investors compare different companies and can help determine which stock offers the better value. Stocks with lower P/E ratios offer potentially higher value compared to the ones with higher P/E ratios, generally speaking. 

However, the P/E ratio does not take the companies’ growth into account.

The PEG ratio, as mentioned earlier, will divide a company’s P/E ratio by its growth rate and is a generally popular option among growth investors

You can end up with significantly different values depending on which ratio you use.

While a stock can be considered a good investment from a P/E standpoint, that may not necessarily be the case from a PEG ratio standpoint. The opposite is also true. 

Neither rate can be considered better or worse - again, it all comes down to your investment strategy. 

If you’d like to start practising trading today with virtual funds via an Admirals demo account, you can do so by clicking the banner below: 

Risk Free Demo Account

Register for a Free Online Demo Account and Master Your Trading Strategy

PEG Ratio: Advantages and Disadvantages 

Just like any other investment strategy, the PEG ratio also has its positive and negative points. We will now look at the advantages and disadvantages of the PEG ratio metric, below. 

Advantages of PEG Ratio 

  • The PEG ratio can complement a stock’s P/E ratio, providing additional information and offering a comprehensive outlook on whether the price is backed up by a solid growth rate. 
  • The PEG ratio also offers a slightly improved future outlook. EGR, which is used to calculate the PEG ratio, will usually take the stock’s prospective growth into account. 
  • Just like most formulas, the PEG ratio allows investors to quickly assess a stock’s value. It considerably speeds up the process, while also providing a relatively simple and quick way to compare different stocks. 

Disadvantages of PEG Ratio 

  • As mentioned earlier, there is no way to determine a company’s growth rate, and you will find multiple EGR numbers available from different sources. In other words, obtaining the right EGR rate from a reliable source is absolutely vital, and finding the right one can be time-consuming at first. 
  • The PEG ratio can create a false and overly optimistic outlook at times. High growth rates aren’t always sustainable. An undervalued stock from a PEG standpoint doesn’t necessarily equate to a good investment. 
  • The PEG ratio lacks some important information. It doesn’t take into account key factors, such as the company’s debts, its cash flow, assets, or management quality, to name a few. 

How to Analyse Stocks Using PEG Ratio 

Using the PEG ratio to analyse stocks gives insight in regards to if a stock is overvalued, undervalued, or fairly priced. 

First of all, you will need to obtain all the necessary figures: the company’s stock price and its earnings per share (or its P/E ratio). Next, you will need to obtain an estimated growth rate from a reliable source, such as an online or local broker. 

With the three numbers in hand, you will need to calculate the company’s PEG ratio using the formula. Let’s use companies A, B and C as an example: 

  • Company A’s stocks sell for $35, with $2.50 earnings per share, and a 10% growth rate. 
  • Company B’s stocks sell for $25, with $2.00 earnings per share, and a 12.5% growth rate. 
  • Company C’s stocks sell for $15, with $1.00 earnings per share, and a 20% growth rate. 

Using the PEG formula, A has a P/E ratio of 14 and a 1.4 PEG ratio. B has a P/E ratio of 12.5, with a PEG ratio of 1.00, while C has a P/E ratio of 1.5 and a PEG ratio of 0.5. 

According to the PEG ratio, C would be the best option available, being an undervalued stock. B is a fairly valued stock, while A would be considered overvalued.

It is important to always keep in mind the importance of an overall financial analysis using various indicators and metrics (rather than solely one) before making any investment or trading decision. 

You may use various financial analysis indicators and more via the popular MetaTrader 5 tool – Download for free as an Admirals user – Click the banner below to download now: 

The World's Premier Multi Asset Platform


What is PEG Ratio: Conclusion 

The PEG ratio is an interesting indicator that investors can use to quickly identify growth stock options. It expands on the price-earnings (P/E) ratio, taking the company’s growth into account as well. 

While the PEG ratio can be a valuable tool to help investors, it also comes with some potential drawbacks, such as finding reliable growth rate indicators.

PEG ratio calculations do not take some other important factors, such as management quality or the company’s balance sheet, into account. 

As usual, it all comes down to your investment strategy. It’s absolutely crucial to understand how PEG ratios work, and the potential benefits and risks of using it as an indicator. 

Trading tools, like MetaTrader 5, will let you set up your own market indicators for reference. MT5 has an automated trading feature, allowing you to set up AI trading bots that will complete your transactions whenever these indicators are met. 

If you decide to start trading, you can sign up for a live account or demo account at Admirals. 

Click the banner below to register for a live account today with Admirals: 

Open a Live Account

Trade the Live Markets and Trade Efficiently

 

What PEG Ratio is Good?

A PEG ratio which is good, generally speaking, would PEG ratio lower than 1.0.

 

Why is a low PEG ratio good?

A low PEG ratio is considered 'good', generally speaking, because this suggests the stock is undervalued and hence could be a good investment option.

 

Other Articles of Interest:

 

INFORMATION ABOUT ANALYTICAL MATERIALS: 

The given data provides additional information regarding all analysis, estimates, prognosis, forecasts, market reviews, weekly outlooks or other similar assessments or information (hereinafter “Analysis”) published on the websites of Admirals' investment firms operating under the Admirals trademark (hereinafter “Admirals”). Before making any investment decisions please pay close attention to the following: 

1. This is a marketing communication. The content is published for informative purposes only and is in no way to be construed as investment advice or recommendation. It has not been prepared in accordance with legal requirements designed to promote the independence of investment research, and that it is not subject to any prohibition on dealing ahead of the dissemination of investment research. 

2. Any investment decision is made by each client alone whereas Admirals shall not be responsible for any loss or damage arising from any such decision, whether or not based on the content. 

3. With view to protecting the interests of our clients and the objectivity of the Analysis, Admirals has established relevant internal procedures for prevention and management of conflicts of interest. 

4. The Analysis is prepared by an independent analyst (hereinafter “Author”) based on Brandie E Blackler, Financial Analyst, personal estimations. 

5. Whilst every reasonable effort is taken to ensure that all sources of the content are reliable and that all information is presented, as much as possible, in an understandable, timely, precise and complete manner, Admirals does not guarantee the accuracy or completeness of any information contained within the Analysis. 

6. Any kind of past or modeled performance of financial instruments indicated within the content should not be construed as an express or implied promise, guarantee or implication by Admirals for any future performance. The value of the financial instrument may both increase and decrease and the preservation of the asset value is not guaranteed. 

7. Leveraged products (including contracts for difference) are speculative in nature and may result in losses or profit. Before you start trading, please ensure that you fully understand the risks involved

TOP ARTICLES
Finance Trends 2024: Top 5 Finance Trends to Watch
The world is constantly changing and that naturally has various effects on investment potential. With 2023 almost in the rearview mirror, it’s already time to start looking into some potential 2024 finance trends. There have been quite a few transformations over the past 12 months, creating some po...
What is the FOMC Meeting Schedule and Why is it Important?
The Federal Open Market Committee (FOMC) acts as the monetary policy maker to the world’s largest economy – the US. The FOMC is part of the Federal Reserve system and its twelve members meet eight times a year. Each board member is considered to be an expert in monetary policy and economics. FOMC...
Recognize Market Movers to Improve Your Trading
Do you already know the market movers? If you’re not 100% sure what they are and how they affect your price chart, this article is for you!Whether you are a beginner in the world of trading and investing, or you are a professional trader, this article can help you define your analysis priorities bef...
View All