Price to earnings growth (PEG) ratio

This key ratio compares the price to earnings ratio to a firm’s earnings growth rate to see whether a share is cheap or expensive.

For example, if last year’s earnings per share was 10p and the current year forecast is 12p the expected earnings growth rate is 20%. Say the P/E ratio – the relationship between the current share price and one year’s earnings per share – is 30 then the PEG ratio is 1.5 (30/20).

A PEG above 1 can be an indicator of an overvalued share, in this case possibly by as much as 50%. Below 1 the ratio can indicate a bargain – this is based on the idea that a P/E ratio of say 10 implies an earnings growth rate of 10%.

If you expect the company’s earnings to grow by 15% then the P/E of only ten suggests the share price undervalues expected earnings growth (the PEG is 10/15 or 0.67). Of course, the theory collapses if the earnings forecast turns out to be optimistic.

MoneyWeek magazine

Latest issue:

Magazine cover
Walking out on the banks

The UK's best-selling financial magazine. Take a FREE trial today.
Claim 3 FREE Issues
Shale gas 'fracking' promises to transform Britain's energy market. Find out what it is, what it means, and how to invest.

More from MoneyWeek

The problem with the Bank of England

Fracking: Nine reasons not to get carried away

Five small-cap stocks worth a flutter

This Dutch company could help us tame floods

ScreenHunter_01 Mar. 25 09.51

Get the latest tips and investment opportunities from MoneyWeek magazine: Claim 3 FREE Issues HERE