Value investors with varied risk appetite are unlikely to count on price/earnings to growth (PEG) ratio among a number of other popular metrics like price/earnings (P/E), price/sales (P/S) or price/book value (P/B) while making investment decisions. This is because they often find this ratio complicated considering the limitations in calculating the future earnings growth potential of a stock.
We note that P/E, P/B or P/S can easily measure whether a stock is at present trading at a discount. However, these fail to give any idea about the future growth trend of a stock. In such a case, even if you buy a stock at less than its fair value, you might still end up paying more.
The PEG ratio on the other hand, with the term ‘growth’ within it, is perfect for accurately calculating the future earnings (EPS) growth rate of a company.
The PEG ratio is defined as: (Price/ Earnings)/ Earnings Growth Rate