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Perhaps the most often cited measure of whether a company's stock is expensive, the price-to-earnings or "P/E" ratio is calculated by dividing a stock's price by its earnings per share ("EPS") over the most recent twelve months, also called the trailing twelve months or "ttm."
For example:
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- If Company X shares trade at $20/share, and the EPS (ttm) is $1.25, the P/E ratio is 16 (20 divided by 1.25).
In effect, this ratio shows the number of years it will take before a share purchased will earn back its purchase price. So, in the above example, it would take 16 years for a share of Company X to earn its cost back. Also, the P/E ratio can make small and large companies more comparable, as it isn't easily affected by the number of shares (which affects other company measures such as market capitalization).
The P/E ratio, however, isn't always comparable from one company to another from a different industry or at a different stage of its growth cycle. It also doesn't account for expected future earnings growth, as it focuses on past earnings. Therefore, some investors prefer the price-to-earnings growth, or "PEG," ratio.
PEG
The PEG ratio contrasts the cost of a share of stock to the estimated value of its future earnings based on projections of its earnings-per-share growth over the next several years.
It's calculated by dividing the P/E ratio by an estimated earnings growth rate, such as the five-year growth rate provided by Yahoo! Finance's analyst estimate pages. In the calculation, the growth rate percentage is treated as a whole number, thus:
- If Company X has a P/E ratio of 30 and its earnings are expected to grow by 25 percent in the next five years, its PEG ratio is 1.2 (30 divided by 25).
Basically, a PEG ratio below one indicates that the market may be undervaluing a company's earnings potential, while a PEG ratio above one can suggest that the market is overestimating a company's earnings power.
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Crypto Whales Are Loading Up — Are You?
New research shows the biggest crypto buyers are back. And this time? They could hold for the possibility that Bitcoin will surpass $100,000 in 2024. You don’t want to miss the next massive crypto bull run like we saw in 2020 and 2021. To know exactly what’s going on and what to buy… Get Access To Benzinga’s Best Crypto Research and Investments For Only $1.