PEG Ratio

The PEG ratio is a powerful formula which compares earnings growth and the Price Earnings Ratio:

Divide the current Price Earnings Ratio by the expected long-term growth rate (in earnings per share)*

• More than 1.0 is poor;
• Less than 1.0 is good;
• Less than 0.5 is excellent.

If dividends are significant, add the Dividend Yield to the growth rate (when calculating the PEG ratio).

* Note

I originally learnt to calculate the inverse (growth rate plus dividend yield, divided by PER) as described by Peter Lynch in One Up On Wall Street (1989) p.198.
In that case, less than 1 is poor, more than 1 is good and more than 2 is excellent.

Example

Intel Corporation had grown earnings per share by an average of 40% p.a. over the period 1992 to 1995. Compare this to their Price/Earnings ratio in the first quarter of 1996, a PE of only 10 times earnings.

10 divided by 40 =  a PEG Ratio of 0.25

This is an exceptional reading! And by mid-2000 Intel's price had appreciated close to 1000%.

How do we calculate the long-term growth rate?

We start with past performance and then study analysts forecasts:

• Examine sales and earnings per share growth over the past 3 to 5 years: 
  What growth rates have been achieved in recent years?
  
• Obtain earnings forecasts from a reliable analyst or use consensus forecasts:
  Are sales and earnings forecasts consistent with past performance?
  

Further details can be found at Value Investing.

Price Earnings Ratio

To calculate the Price Earnings Ratio:

         Divide current market price by the last 4 quarters earnings per share.

There is no need to calculate this yourself, look in the financial section of your newspaper and you should the current find Price Earnings Ratio (PE or PER)  and Dividend Yield quoted along with market prices. The information is also available from most online brokers.