Price/earnings to growth (PEG)

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    The PEG ratio is widely used to determine a stock’s potential value while taking into account earnings growth. It is a projection rather than an actual figure. Many investors prefer PEG to the price/earnings ratio (P/E) as an indicator of a stock’s value, because it also takes growth into account.

    This is because using only the P/E ratio can make high-growth companies appear overvalued compared to others. Dividing the P/E ratio by the PEG rate produces numbers that make it easier to compare companies that have different growth rates.

    The formula for calculating the PEG is:

    Price earnings to growth

    That means if a company’s stock has a P/E of 30% and the expected growth in earnings for the next year is 15%, the PEG is 2 (P/E = 30 / 15 = 2).

    The smaller the number, the better the investment prospects, because higher earnings are expected in the future and the company could be undervalued. For a stock trader, the PEG is important because investors are usually more concerned about the future than the past.

    However, be aware that because this ratio produces projected figures it is not accurate and should only be used as an indicator. It is also important to know which time period is being used for the calculation as this can vary across different companies, which may use one year, five years or even ten years.