Value investors often look at the price earnings ratio of a company to see if the price of the stock is potentially undervalued. The price earnings ratio approximates to the number of years of earnings represented by the current share price. If this ratio is low, the value investor may want to investigate further to see if there is a logical reason for the stock price being lower than might be expected. This would generally involve a look at the fundamentals of the company, including an assessment of the management, to arrive at an estimate of the intrinsic value of the company.
The price earnings growth ratio takes the price earnings ratio and divides this by the annual growth rate of earnings per share. Clearly the higher the annual growth rate of earnings per share the lower will be the figure that results from this calculation. The PEG may result in a lower figure for a share that has a slightly higher price earnings ratio but whose earnings per share are growing faster. The PEG may indicate that this share is more attractive because it not only can be bought cheaply in relation to its value but will grow at a faster rate and yield a higher return for the investor.
A low PEG ratio may therefore be indicating a share that is both a value stock and a growth stock. Investors have come to realize that there is no necessary contradiction in this. A value stock does not necessarily have to be a share in a very traditional company that performs solidly without spectacular growth. A growing company can also be undervalued in relation to its intrinsic value as shown by the fundamentals and its shares can also represent a value stock.
Please login to view the rest of this article - Not subscribed? Get our adfree exclusive content for only a few dollars a month.
It also helps us fund our operations so think of it as supporting quality journalism.