The PEG ratio is a comparison between the price of a stock, a stock's P/E and the expected EPS yearly growth.
To calculate PEG: PEG = (price / annual earnings) / (% annual growth)
What are the accepted values for PEG?
Generally, values of greater than 1 show that the company is possibly overvalued or expects that the companies future earnings per share growth will be higher than the market estimates (growth stock). With PEG values of less than 1 means that the company may be undervalued or that the companies future earnings per share growth will be lower than the market estimates.
Problems with PEG:
1) PEG ratios work best with growth companies. Income stocks/companies are generally well established and offer less growth opportunities.
Why use PEG?
PEG gives a relative value for a companies stock price based on future growth. Tends to work well with companies that are in the growth stage of their life cycle.
Company XYZ trades at 20$
Company XYZ is expected to have a 25% earnings growth (1.25/1 = 1.25 or 25% positive growth)
Note: Ratios should not be used as the only valuation method since ratios are only as reliable as the data on which they are based. Ratio's should therefore be supplemented with other complementary methods to achieve a reasonable opinion.