In order to evaluate a stock, we often look at the PE Ratio (Forward PE or Trailing PE).
But how do we interpret it?
A. Does having a high PE Ratio such as a Forward PE of 35 or 40, bad? Does having a low PE Ratio such as 8 or 10 mean the stock is good?
Not necessarily. A stock with a high forward PE may be overpriced. However, if the growth and yield is good enough, may be the high PE is worth it.
A stock with a low forward PE might be very undervalued. On the other hand, there might be a reason the stock has a low PE ratio and the stock may be in bad shape.
So how do we figure out whether a stock is properly overvalued or undervalued?
B. Use the PEG Ratio to balance PE Ratio and Growth
The PEG Ratio is the PE Ratio divided by the Growth Rate.
In InvestDashboard.com, the PEG Ratio uses the Forward PE ratio, and uses an analyst estimated 5 Year Earnings growth rate.
With Apple (AAPL), the Forward PE Ratio is 11.74, while the 5 Year Estimated Growth Rate is 14.71%.
So the PEG Ratio of Apple is:
PEG Ratio = PE(Apple) / Growth(Apple) = 11.74 / 14.71 = 0.80.
C. How do we interpret the PEG Ratio?
In general, the lower the PEG Ratio, the better value the stock is. The higher the PEG Ratio, the worse value the stock is.
A PEG Ratio between 0 and 1 is an excellent value! This means that the stock is estimated to grow faster than it’s PE Ratio.
A PEG Ratio greater than 2 is a very bad value. You can even consider selling some stocks with PEG Ratios greater than 2.
A PEG Ratio between 1 and 1.5 is still a good value, and PEG Ratios between 1.5 and 2 can still be considered but is on the more expensive side.
D. What about Yield? What is the PEGY Ratio?
An improvement over the PEG Ratio is the PEGY Ratio. It is similar to the PEG Ratio but PEGY Ratio includes the stock’s yield.
PEGY Ratio = Forward PE Ratio / (5 Year Estimated Growth + Yield)
PEGY Ratio (IBM) = 9.02 / (6.50 + 3.60) = 0.89
You can use the PEGY ratio the same way as the PEG Ratio.
InvestDashboard.com prefers using PEGY ratio because it is more expressive than just the PEG Ratio.
E. What is the CPEGY Ratio?
The CPEGY Ratio is similar to the PEGY Ratio, except the cash per share of a stock is subtracted from the PE ratio.
CPEGY Ratio = ((Price – Cash Per Share)/Earnings) / (5 Year Estimated Growth + Yield).
F. It is also good to compare the PEGY Ratio numbers with the PEGY ratios in the industry.
It is also good to compare PE Ratios, and PEGY ratios with other stocks in a stocks industry. Each industry might have slightly different numbers than other industries.