Academy – Sunday Learning Equisigma Investor Series

Lesson 2: PEG Ratio – Why a High P/E Stock Can Sometimes Be Cheaper Than a Low P/E Stock

A Quick Recap

Last week we learnt that the Price-to-Earnings (P/E) Ratio tells us how much investors are willing to pay for every 1/- of a company's earnings. However, P/E alone does not tell us how fast those earnings are growing.

What is the PEG Ratio?

PEG stands for Price/Earnings-to-Growth Ratio. It adjusts the P/E ratio for the company's expected earnings growth, making it a more balanced valuation measure.

Formula

PEG Ratio = P/E Ratio ÷ Annual Earnings Growth Rate (%)

Illustration

Company	P/E	Growth	PEG
A	12	5%	2.4
B	40	50%	0.8

Company B appears expensive on P/E alone, but when growth is considered its PEG is more attractive.

How to Interpret PEG

·         PEG below 1: Often attractive relative to growth.

·         PEG around 1: Fair valuation in many cases.

·         PEG above 1: May indicate richer valuation; compare with peers.

Limitations

·         Growth forecasts may change.

·         Not useful for loss-making companies.

·         Less reliable for highly cyclical businesses.

Key Takeaways

·         P/E tells you what you pay; PEG tells you what you pay relative to growth.

·         Never judge a stock on P/E alone.

·         Compare PEG only within the same industry.

·         Combine PEG with ROE, ROCE, debt and cash-flow analysis.

Equisigma's Practical Approach

Our research process never relies on a single ratio. We evaluate valuation, growth, profitability, cash flow, balance-sheet strength, management quality and business outlook before recommending any company.

Quiz of the Week

1.       What does the 'G' in PEG represent?

2.       Can a high P/E stock still be attractive?

3.       Which PEG is generally more attractive: 0.8 or 2.0?

4.       Why should PEG not be used in isolation?

Coming Next Sunday

Price-to-Book (P/B) Ratio – Why Banks and NBFCs Cannot Be Valued Using P/E Alone.

Best Regards

Team Equisigma