The PEG ratio, or the price/earnings to growth ratio, is a stock’s price to earnings ratio divided by its earnings growth rate over a defined period of time.
The PEG ratio is a metric used by traders to complement or supplement the classic P/E ratio by incorporating a measure of a company’s expected future earnings.
Using the PEG Ratio in Day Trading
While the classic P/E ratio is still a very useful and broadly-applicable metric, it inevitably leads to the question of a firm’s projected future earnings growth.
Therefore, the PEG ratio is a powerful supplement or complement to the P/E ratio that offers a metric for the next logical step in earnings analysis while maintaining the same cogent underlying logic as the P/E ratio.
Issues with the PEG Ratio
The issues and difficulties in developing and the applying the PEG ratio arise in the determination of the earnings growth denominator.
There is no accepted rule for determining a company’s rate of earnings growth. Few companies have earnings that have grown, or declined, on a linear path, and assuming that future earnings can simply be projected from past earnings is an obtuse form of analysis.
On the other hand, projecting future earnings growth based on analysis of the company’s current operations risks falling into the same overly optimistic or pessimistic perspective that leads to extreme P/E ratios in the first place, which would neutralize the objective perspective that makes the P/E ratio such a popular metric.
The PEG ratio is a useful supplement or complement to the P/E ratio that maintains the P/E ratio’s cogent underlying logic in the evaluation of stock prices.
However, there are issues and complications that arise when attempting to develop a measure of future earnings. This indicator or measurement should always be used in conjunction with other indicators or measurements to help make decisions when trading or investing.