Infrastructure Finance: An Introduction
Traditional economists are of the opinion that infrastructure is the heart of the economy. Empirical data clearly shows that given a choice, investors prefer to invest their money in countries whose infrastructure is more developed. Hence, it can be said that rapid infrastructure development is one of the most basic ways in which a country […]
Floatation Costs and Investment Banking
Whenever companies need to raise money by accessing the public markets, they have to use the services of investment banks. This is because investment bankers have a readymade network which they use to sell securities to the general public. Investment banks are the central character for a company if it needs to go public. It […]
History of the Forex Market: The Gold Standard
The word “money” has not always meant what it means today. Today when we use the word “money” we refer to “currency”. Both, money as well as currency used to mean very different things until about a couple of centuries ago. Prior to the monetary system that we have today, the world was on a […]
Nominal and Real Value of Money
The previous article was an introduction about the two basic decisions that corporate finance helps a corporation in making. Prima-facie, these two decisions may look pretty simple. After all everyone raises money in their daily lives and puts it to productive use. Simple accounting can tell us whether or not we should make those financing […]
Objectives of Financial Modelling
Financial modeling enables key personnel to make better decisions. These models are used for various types of decision making. Hence, one model cannot be used for all types of decision making. As a result, several different types of models have to be created. Each of these models’ requires different inputs and provides different outputs. A […]
The Price Earnings Growth (PEG) Ratio is one of the first variations that were made to the Price to Earnings Ratio to make it more meaningful. The full form of the PEG Ratio is Price Earnings Growth ratio.
Instead of being a two way comparison between price and earnings, the PEG ratio makes a three way comparison. The first step is to arrive at the price to earnings ratio whereas the next step is to divide this ratio by the growth rate of the company to arrive at the PEG ratio.
The PEG ratio was developed because investors argued that current stock market price is an expectation of future gains to be made by the company in question. Therefore valuing it solely on the basis of the current year’s earnings is incorrect. They realized that two companies could currently have the same earnings but the one that has been growing its earnings faster needs a better valuation. It is for this reason that they started factoring in growth rates before concluding whether the company is fairly prices.
PEG Ratio = Price to Earnings Ratio / Growth Rate
The growth rate is calculated based on historic data. Analysts could use as much data as they feel is comfortable without losing the current trend of earnings of the company in question.
This growth rate is usually expected as a percentage out of 100. For example, if a company has a growth rate of 20% and a P/E Ratio of 30. Then the PEG Ratio will be:
PEG Ratio = 30/20 = 1.5
The PEG Ratio assumes that the current rate of growth of the company is expected to continue. However, in reality trends usually last for 4 to 5 years. So by the time the analyst does figure out the trend, it would be affected by the cyclical nature of business and may have changed.
Therefore if the PEG ratio is equal to 1, then the company is fairly priced. This means that investors must actively scout for companies with PEG ratios less than 1.
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