E ratio is higher for a company with a higher price to earnings ratio rate. E ratio would make high-growth companies appear overvalued relative to others. E ratio by the earnings growth rate, the resulting ratio is better for comparing companies with different growth rates. The PEG ratio is considered to be a convenient approximation.
It was originally developed by Mario Farina who wrote about it in his 1969 Book, A Beginner’s Guide To Successful Investing In The Stock Market. The growth rate is expressed as a percent value, and should use real growth only, to correct for inflation. E of 30, it would have a PEG of 1. E ratio used in the calculation may be projected or trailing, and the annual growth rate may be the expected growth rate for the next year or the next five years.
PEG is a widely employed indicator of a stock’s possible true value. Similar to PE ratios, a lower PEG means that the stock is undervalued more. The PEG ratio of 1 is sometimes said to represent a fair trade-off between the values of cost and the values of growth, indicating that a stock is reasonably valued given the expected growth. A crude analysis suggests that companies with PEG values between 0 and 1 may provide higher returns. PEG ratios calculated from negative present earnings are viewed with skepticism as almost meaningless, other than as an indication of high investment risk. When the PEG is quoted in public sources it makes a great deal of difference whether the earnings used in calculating the PEG is the past year’s EPS, the estimated future year’s EPS, or even selected analysts’ speculative estimates of growth over the next five years. Use of the coming year’s expected growth rate is considered preferable as the most reliable of the future-looking estimates.
The PEG ratio is commonly used and provided by numerous sources of financial and stock information. Despite its wide use, the PEG ratio is only a rough rule of thumb. Growth rate numbers are expected to come from an impartial source. This may be from an analyst, whose job it is to be objective, or the investor’s own analysis. Management is not impartial and it is assumed that their statements have a bit of puffery, going from a bit optimistic to completely implausible. This is not always true, since some managers tend to predict modest results only to have things come out better than claimed.