Ask Colin

Could you explain the idea behind the PEG ratio?

The idea of the PEG ratio is that a fair value for a stock is when its rate of growth in earnings per share is about the same as its PE ratio. The example on my web site shows how you make the calculation.

If the fair value is 1, then it follows that when the PEG ratio is greater than 1 (PE ratio is greater than EPS growth), then the market is paying too much for the stock and it is therefore too expensive.

Likewise, if the PEG ratio is less than 1 (PE ratio is less than EPS growth), then the market is underpricing the stock and it is therefore cheap.

You can not rely on the PEG ratio entirely. It is simply a filter to get a short list of stocks for further research. Always remember that a stock could be cheap because the market does not expect it to reproduce the last profits in the future.

There is quite a lot on the Internet about it. Put PEG+ratio into any decent search engine.

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