| The two most important numbers that | | | | earnings growth in the future, then the share |
| investment analysts look at when evaluating a | | | | price will go up. It is not easy to discern whether |
| stock are the P/E ratio and the PEG ratio. The | | | | a high or low ratio is good or bad; you need to |
| former has been around for as long as the stock | | | | take into account the expectations for future |
| market itself, the latter originated more recently. | | | | earnings growth to understand if the P/E ratio is a |
| A thorough analysis of these dueling indicators | | | | positive or a negative. |
| reveals that one is definitely superior to the other. | | | | The pitfalls of using the P/E ratio to interpret the |
| The P/E is the price-to-earnings ratio. It is used to | | | | relative worth of a stock resulted in analysts |
| calculate how expensive or how cheap a stock is | | | | coming up with a better measurement, which is |
| relative to its earnings. Using it, an investor can | | | | known as the PEG ratio. The PEG refers to the |
| get a sense of whether a stock might be | | | | price-to-earnings growth ratio. It is calculated like |
| overvalued or undervalued. The ratio is calculated | | | | this: |
| as follows: | | | | PEG = (P/E) / Annual earnings-per-share growth |
| P/E = Price per share / Earnings per share | | | | The lower the PEG ratio, the more undervalued |
| The price per share is the current market price | | | | the company is. A PEG ratio of 1 or less is |
| for a single share of stock. The earnings per | | | | considered excellent. For example, if a company |
| share is the net income divided by the total | | | | has a P/E ratio of 30, and annual |
| number of shares outstanding. You can find net | | | | earnings-per-share growth of 50%, then the PEG |
| income by looking at a current income statement, | | | | would be 0.6, making this company an excellent |
| which almost all corporations now make available | | | | buy because it is undervalued and the stock price |
| on their company website. | | | | will almost definitely climb. However, if a company |
| The lower the P/E, the cheaper the stock is. The | | | | has a PEG of 1.5, that means that the stock price |
| higher the ratio, the more expensive the stock is | | | | is high relative to the earnings growth, which |
| relative to its current earnings. However, that | | | | means that unless the company is supposed to |
| does not give you the full picture. The reason | | | | grow at a faster rate in the years head, the |
| why some companies sometime trade at very | | | | stock price might not hold up. |
| high price-to-earnings ratios is because they are | | | | So, it is obvious that the PEG is a much more |
| expected to grow tremendously in the months | | | | valuable tool for investors to use. It reveals |
| and years ahead. So, investors are willing to pay | | | | whether the high price of a stock is justified |
| more than what the company is currently worth | | | | based on whether earnings will grow enough to |
| because they feel the company will be worth a | | | | continue to drive the stock higher. The P/E falls |
| lot more in the future. So, you should not | | | | short in this regard because it does not take into |
| necessarily run away from a company with a high | | | | account by what percentage earnings are growing |
| P/E. In fact, those companies are sometimes the | | | | each year. Increasing earnings are the driving |
| best investments, because if their earnings climb | | | | force behind an increase in the price of a stock. |
| tremendously, then the stock will pay a large | | | | Therefore, using the PEG, you can truly ascertain |
| dividend in the future (for the uninitiated, dividends | | | | whether the price is currently too high and |
| are a percentage of the profits of a company | | | | whether it is a good time to buy the stock. |
| that are distributed to its shareholders). So, a high | | | | I hope this information has helped you form an |
| P/E ratio can be a very good thing or a very bad | | | | understanding of how to evaluate stock prices. |
| thing. | | | | Try to set aside some money for investing, and |
| As with a high P/E, a low P/E can also be tricky. | | | | begin to analyze stocks and buy the ones that |
| If it is low, this could be an indication that the | | | | have a low PEG. They may not go up right away, |
| earnings of the company are expected to | | | | but in the long run they should increase |
| plummet, causing investors to run away from the | | | | significantly, unless there is something |
| stock, resulting in a low share price. Or, the low | | | | fundamentally wrong with the company. Research |
| ratio might indicate that the company is currently | | | | carefully the companies you are going to invest in |
| undervalued, making it a good buy because as | | | | and you will do fine. |
| long as the company is expected to have stable | | | | |