What is PEG Ratio Formula?

The term “PEG ratioPEG RatioThe PEG ratio compares the P/E ratio of a company to its expected rate of growth. A PEG ratio of 1.0 or lower, on average, indicates that a stock is undervalued. A PEG ratio greater than 1.0 indicates that a stock is overvalued.read more” or Price/Earnings to Growth ratio refers to the stock valuation method based on the growth potential of the company’s earnings. The formula for the PEG ratio is derived by dividing the stock’s price-to-earningsPrice-to-earningsThe price to earnings (PE) ratio measures the relative value of the corporate stocks, i.e., whether it is undervalued or overvalued. It is calculated as the proportion of the current price per share to the earnings per share. read more (P/E) ratio by the growth rate of its earnings for a specified time period.

PEG Ratio Formula can be expressed as below,

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where,

P/E ratio = Stock Price / Earnings per share

There are two methods of calculating the PEG ratio, and they are:

  • Forward PEGTrailing PEG

Forward PEG: In this method, the earnings growth rate is determined based on the annualized future growth rate for a certain period, usually up to five years.

Trailing PEG: The earnings growth rate is determined based on the stock’s trailing growth rates. The sources of such growth rate could be from the previous 12 months, the last fiscal yearFiscal YearFiscal Year (FY) is referred to as a period lasting for twelve months and is used for budgeting, account keeping and all the other financial reporting for industries. Some of the most commonly used Fiscal Years by businesses all over the world are: 1st January to 31st December, 1st April to 31st March, 1st July to 30th June and 1st October to 30th Septemberread more, or some multiple-year historical average.

Explanation

Example of PEG Ratio Formula (with Excel Template)

Let’s see some simple examples of  PEG Ratio Formula to understand it better.

  • Firstly, determine the current price of the company stock from the stock market. Next, determine the net income of the company from the income statement. Then, figure out the portion of the profit going to the shareholders after the deduction ofu00a0preference dividends. Now, divide the portion of the net income by the outstanding no. of shares to arrive at theu00a0earnings per share or EPS. EPS = (Net income u2013 Preference dividends) / No. of outstanding equity shares Next, divide the current stock price of the company by its earnings per share to calculate the P/E ratio. Next, determine the future earnings growth rate based on the financial projection of the company as per the forwarding PEG ratio method. The financial projection is prepared based on the company-specific plans and the industry’s future growth potential, and the overall market. On the other hand, the PEG ratio can be derived by using the company’s past performance as per the Trailing PEG ratio. Finally, the formula for PEG ratio calculation is derived by dividing the P/E ratio by the growth rate of its earnings for a specified time period, as shown below. PEG ratio = P/E ratio / Earnings growth rate

EPS = (Net income u2013 Preference dividends) / No. of outstanding equity shares

PEG ratio = P/E ratio / Earnings growth rate

Let us take the example of ABZ Ltd, which manufactures mobile phones. The company has witnessed a tremendous change in the market potential with the launch of its new product, and as such, future growth is expected to be higher than in the past. The stock of the company is currently trading at $65 per share. 

Below is given data for calculation of forwarding PEG ratio and a trailing PEG ratio of company ABZ Ltd

P/E Ratio

Therefore, the calculation of the P/E ratio will be as follows

P/E ratio = Current price / EPS for FY18 = $65 / $3.61

P/E Ratio= 18.00

Trailing Earnings Growth Rate

Therefore, the Earnings growth rate for the trailing five years can be calculated as,

The earnings growth rate for trailing five years = (EPS for FY18 / EPS for FY14)1/4 – 1

= ($3.610 / $3.000)1/4 – 1

Trailing Earnings Growth Rate = 4.74%

Trailing PEG Ratio

Therefore, the calculation of the Trailing PEG ratio will be as follows,

Trailing PEG ratio = 18.00 / 4.74

Trailing PEG Ratio= 3.80

Forward Earnings Growth Rate

Therefore, the calculation of the Earnings growth rate for the future five years will be as follows

The Earnings growth rate for future five years = (EPS for FY23P / EPS for FY18)1/5 – 1

=($6.078 / $3.610)1/5 – 1

Forward Earnings Growth Rate = 10.98%

Forward PEG Ratio

Therefore, the calculation of Forward PEG ratio will be as follows,

Therefore, Forward PEG ratio = 18.00 / 10.98

Forward PEG Ratio= 1.64

Therefore, it can see that the PEG ratio is expected to improve in the coming years, which is a good indication for the company.

Relevance and Use

It is very important to understand the concept of the PEG ratio because an investor uses this ratio to analyze the earning potential of a stock. The degree of variation (a spread of over or under-priced stock) of the PEG ratio varies across the industry and company type. A stock with a low P/E ratio may seem like a good buy, but then taking the company’s growth rate into account to derive the PEG ratio of the stock, the story might change a lot. Additionally, a lower PEG ratio indicates that the stock may be undervalued, given its earnings performance.

However, a broad rule of thumb is that it is desirable to have a PEG ratio of less than one. Further, the accuracy of the PEG ratio is as good as the inputs used, so one should be careful in using the input data. For instance, historical growth rates may provide an inaccurate PEG ratio if the future growth potential is likely to deviate from historical growth rates. Consequently, calculation methods using future growth and historical growth are distinguished by “forward PEG” and “trailing PEG,” respectively.

This article has been a guide to PEG Ratio Formula. Here we discuss how to calculate PEG Ratio and the practical examples and downloadable excel sheet. You can learn more about accounting from the following articles –

  • What is Price to Book Value Ratio?What Is Price To Book Value Ratio?Price to Book Value Ratio or P/B Ratio helps to identify stock opportunities in Financial companies, especially banks, and is used with other valuation tools like PE Ratio, PCF, EV/EBITDA. Price to Book Value Ratio = Price Per Share / Book Value Per Share
  • read morePrice to Cash Flow MultiplePrice To Cash Flow MultiplePrice to Cash Flow Ratio is a value indicator that measures a company’s stock price in relation to the cash flow amount it generates. This is determined as the ratio of Price Per Share to Operating Cash Flow Per Share. read moreCalculate Forward PECalculate Forward PEForward PE ratio uses the forecasted earnings per share of the company over the next 12 months for calculating the price-earnings ratio. Forward PE ratio formula = Price per share/Projected earnings per share
  • read moreTrailing PE vs. Forward PE RatioTrailing PE Vs. Forward PE RatioTrailing PE uses earnings per share of the company over the previous 12 months for calculating the price-earnings ratio. In contrast, Forward PE uses the forecasted earnings per share of the company over the next 12 months for calculating the price-earnings ratio.read more