Fundamental analysis is the method to understand the real value of a particular stock. One of the tools in the fundamental analysis is Price per Earnings (P/E) to Growth (PEG) ratio. These two tools help to understand the actual value as well as the potential for earning.
In calculating Price per Earnings to Growth (PEG) ratio to evaluate stocks, we need to first understand the Price/Earnings (P/E) ratio.
Calculating the P/E Ratio
P/E ratio is the most essential component for PEG ratio calculation. To calculate it you need to divide a particular stock’s current share price by its earning per share (EPS).
P/E Ratio = Stock’s Current Share Price / Earnings per Share (EPS)
P/E ratio gives you the opportunity to compare the relative value between stocks and determine if the market prices a stock higher or lower to its earnings.
Calculating the PEG Ratio
Similar to P/E ratio, the PEG ratio also allows you to know the real value of a stock. The only different is PEG ratio also considers the company earnings growth. Thus, it gives you a more complete picture of a stock fundamentals than the P/E ratio.
To calculate PEG ratio, you need to divide the P/E ratio by the stock’s projected growth of earnings.
PEG Ratio = Price to Earnings Ratio / (Projected or Actual) Earnings Growth
Lower PEG ratio means that the stock may be undervalued to its earnings projection. Contrarily, a higher number of PEG ratio means that the market is possibly overvalued the stock.
Interpreting the Result
With the conjunction of P/E and PEG ratio tells you a better picture than a P/E ratio alone. Stocks with high P/E seems overvalued, thus they are not good choices. Yet, another calculation on the same stock, assuming it has growth estimates, can bring you a different lower number. That indicates, the stock still can be a good choice.
Yet, without the projected growth, you can get high PEG ratio that better indicates you should not purchase the stocks.
