- The PE ratio, or Price-to-Earnings ratio, is one of the oldest formulas in investing. The PE ratio (which is used in calculating the PEG) compares a stock's current price to its recent earnings. For instance, a stock trading for $50 that has been earning $5 per share would have a PE of 50/5, or 10.
- Thus, the PE ratio takes the past into account, but does not give the investor any information about the future. Although the future performance of a stock cannot be 100 percent accurately predicted, analysts can provide educated estimates of company growth.
- PEG is created by dividing the PE ratio by the stock's expected annual growth rate. The resulting number takes into account both past performance and expected future performance, providing an indicator of how well a stock is currently valued.
- A PEG greater than 1 indicates a stock that is overvalued, perhaps due to hype and speculation, insufficient growth, a poor earnings history or substantial dividend returns (see Resources).
- A PEG lower than 1 indicates a stock that is undervalued, and perhaps a good buy. This might indicate a strong business that analysts are ignoring, or one with higher-than-expected growth.
- One of the most significant downsides of the PEG ratio is that it fails entirely to take into account a stock's dividend earnings. High dividend earnings can be an offset to higher stock prices for the investor interested in immediate and consistent returns.
