Sunday, March 13, 2016

PEG Ratio?

I'm not stupid enough to think that I know everything. Investing is one large process of learning more and more each day if you're doing what you're supposed to be doing. With this being said, I personally have never been one to use a PEG ratio as a unit of measure for the evaluation of a stock. Why you ask? It's because I didn't know what it was, what it was for, and didn't yet know how to use it to my advantage. Being a young investor, I've got lots to learn so I have to take it day by day and subject by subject. As this is the case, let's learn about PEG ratios.

What is a PEG ratio? 

A PEG ratio, or Price/Earnings to Growth ratio is a "stock's P/E ratio divided by the growth rate of its earnings for a specified time period." - Investopedia

**P/E Ratio divided by EPS Growth = PEG Ratio

How can it be used to evaluate a company?

It can be used to aid in the evaluation of a stock because it lays the P/E ratio against the company's growth. This means that just as I have been using a company's P/E ratio to see if a stock was under or over valued, the PEG ratio can be used hand in hand with it to serve the same purpose but for the future growth of the company. When looking at the PEG ratio, a lower number is better. The lower it is, the more undervalued that company may be and the better discount you may find on it.

This isn't to say that this should be relied on in all circumstances. As Investopedia loves to remind me when learning about PEG ratios, this isn't an all seeing eye. Like all ratios used to evaluate a stock, they need to be seen in a larger picture across the industry. Some industries may see a somewhat large PEG ratio to be very normal and actually at a discount while others may need an incredibly small PEG to actually be considered at a discount and not just falling because of the failure of the company.

In addition, a PEG may be thrown off by a stock that pays a premium dividend. This is because the PEG ratio doesn't necessarily take into account the dividends paid. When looking at a PEG ratio, I learned that you need to add the dividends into the equation when calcuating the PEG ratio to show the true value of the stock. Where it may sometimes feel over valued, when you add the dividends in, it may actually bring further value and make it a fair or discounted stock.

That's all I've got today but I would love to hear any thoughts that my fellow investors have on how I can better use PEG ratios in the future or even stories about pitfalls of it so I know further what to watch out for. Thanks for your time and take care.

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