We are going to run through a few valuation multiples in the next few posts that are used to compare different companies, and the different strengths and weaknesses of each multiple for analysing companies. The ratios we will look at are the P/E, P/B, P/Sales, PEG and EV/EBITDA ratios. The next ratio up is the PEG Ratio.
The PEG ratio is calculated as the PE ratio divided by the % growth rate in earnings of the company. So for instance if the PE ratio is 10 and the company has aconsistent 10% earnings growth rate, then the PEG ratio of the company is 1. In general the PEG ratio is calculated using a forward PE ratio and the projected growth rate, so it is an estimate, not a historical value. The PEG ratio is generally used in the same way as PE ratio, in that a low PEG ratio is generally considered to be an indication of better value. A low PEG ratio indicates that less of the potential earnings growth in a stock is priced in. Alternatively a high PEG ratio indicates that the potential growth in a stock is fully priced in. In general companies with a PEG ratio less than 1 are considered to be high value.
Advantages of the PEG ratio include:
Disadvantages of the PEG ratio include: