Price/Earnings-to-Growth Ratio, or PEG Ratio in English, is a financial indicator that measures whether a company's stock price is overvalued or undervalued and estimates the company's future growth. P/E growth rate is calculated by dividing a company's price-to-earnings ratio (P/E Ratio) by its expected earnings per share growth rate. Generally speaking, a P/E growth rate greater than 1 indicates that the company's current stock price is overvalued, and a P/E growth rate less than 1 indicates that the current stock price is undervalued. Therefore, P/E growth rate is the most valuable company indicator considered by investment masters such as Peter Lynch. Peter Lynch believes that the P/E growth rate of growth companies should be close to the value 1. The P/E growth rate solves the biggest weakness of the P/E ratio calculation, which is the inability to assess a company's future growth. Therefore, compared to the price-to-earnings ratio, PEG can be said to be a better financial indicator. However, there are still certain restrictions in the use of the price-to-earnings growth rate. For example, a company must have a historical earnings per share growth rate before it can calculate the price-to-earnings growth rate. At the same time, for companies whose growth rates fluctuate too much, the price-to-earnings growth rate cannot be used for accurate valuation. When calculating earnings per share, we use diluted earnings per share (Diluted EPS) to calculate because companies usually issue potentially dilutive shares to shareholders and employees. Using the number of diluted outstanding shares to calculate earnings per share can obtain more realistic investment returns that ordinary shareholders can obtain. The above formula does not take into account the impact of dividends. The following adjusted price-to-earnings growth rate (Dividend-Adjusted PEG Ratio, referred to as PEGY Ratio), the adjusted price-to-earnings growth rate takes into account the impact of dividends: Adjusted P/E growth rate = P/E ratio / (EPS growth rate + dividend rate) PEGY Ratio = PE ratio / (EPS Growth Rate + Dividend Yield) Among them, the calculation formula of dividend rate is as follows: Dividend rate = annual dividend per share / current stock price Dividend Yield = Yearly Dividend / Stock Price After calculating the Dividend Yield and Earnings Growth Rate, you need to bring the percentage values directly into the company to calculate the adjusted P/E growth rate. For example, if the calculated dividend rate is 2% and the earnings per share growth rate is 8%, you need to bring 2 and 8 directly into the formula instead of 2% and 8%. For example, the current stock price of Company A is $100, the company's earnings per share EPS = $5, and the earnings per share growth rate EPS Growth = 8%. In addition, the dividend rate Dividend Yield = 2%. Then, PE Ratio = Stock Price / EPS = $100/$5 = 20 Simple PEG: PEG = PE Ratio / EPS Growth = 20/8 = 2.5 Adjust PEG: PEGY = PE Ratio / (EPS Growth + Dividend Yield) = 20 / (8 + 2) = 2 It can be seen that for listed companies that pay dividends, using PEGY is more accurate. How to calculate Apple's P/E growth rate? This chapter will perform example calculations by using Apple's 10-K financial report released in September 2021: Apple’s latest stock price, available from AAPL’s investment portal, is $149.64 Its past diluted earnings per share (Diluted EPS) can be obtained from AAPL's past 10-K financial reports: So Apple’s current P/E ratio is calculated as: P/E ratio = current stock price / earnings per share = $149.64 / $5.61 = 26.67
Next, let's calculate Apple's earnings per share growth rate. Apple's diluted earnings per share over the past few years are listed below. These data can be obtained from AAPL's 10-K financial reports over the years: Year-on-year diluted earnings per share growth rate 2013 $5.68 2014 $6.45 13.56% 2015 $9.22 42.95% 2016 $8.31 9.87% 2017 $9.21 10.83% 2018 $11.91 29.32% 2019 $2.97 75.06% 2020 $3.28 10.44% 2021 $5.61 71.04% average growth rate 11.65% Based on the diluted earnings per share in previous years, we can calculate the corresponding diluted earnings per share growth rate. So, AAPL's average EPS growth rate was 11.65%. Since Apple pays dividends, let's calculate the Dividend Yield. The annual dividend can be found in the Statements of Shareholders’ Equity in AAPL’s 10-K financial report. So, the annual dividend for 2021 is $0.85. Dividend Yield = Annual Dividend / Current Stock Price = $0.85 / $137.35 = 0.62% So Apple’s adjusted P/E growth rate is: = 24.48 / (11.65 + 0.62) = 1.995 Note that when substituting the earnings per share growth rate and dividend yield into the formula, you need to use values without the percent sign %. What investment guidance does the price-to-earnings growth rate have? P/E growth is one of Peter Lynch's favorite measures of a company's intrinsic value, and investors often use it to gauge whether a company's share price is overvalued or undervalued. When the P/E growth rate is greater than 1, the company's stock price is overvalued; When the P/E growth rate is equal to or less than 1, the company's stock price is undervalued; Peter Lynch believes that a company's reasonable P/E value should be close to its earnings per share growth rate. Therefore, high-growth companies can have higher P/E values, while low-growth companies should also have lower P/E values. At the same time, the price-to-earnings growth rate can also be used to compare different companies in the same industry, but the companies to be compared need to be in a similar development period, otherwise there will be a large evaluation bias. What are the limitations of using price-earnings growth rate? When using the price-to-earnings growth rate to evaluate a company's stock price, because the calculation formula requires the use of the earnings-per-share growth rate, and the earnings-per-share growth rate relies on historical values, the price-to-earnings growth rate cannot be used to measure companies in their early stages of development or for companies whose earnings per share are often negative. For companies whose growth rates fluctuate too much, the future earnings per share growth rate cannot be accurately predicted because the average cannot be accurately measured amid excessive earnings fluctuations. Therefore, it is also impossible to use the price-to-earnings growth rate to measure the stock price of such companies. Since the price-to-earnings growth rate uses the earnings per share growth rate as valuation, in addition to referring to past historical values, it also includes investors' subjective understanding of the company. Different investors may propose different expected earnings per share growth rates for the same company. In other words, different investors may calculate different price-to-earnings growth rates for the same company. More macro data What is the Federal Reserve Balance Sheet? Explore the Fed’s 24 primary dealers What is the National Financial Conditions Index? Published by the Chicago Fed What is the Buffett indicator? Buffet Indicator What is the U.S. Treasury Volatility Index? Move Index What dollar index? US Dollar Index What are bank deposit reserves? Bank Reserves What are open market operations? Open Market Operations What is the reserve balance interest rate? Interest in Reserve Balances What is the Personal Consumption Expenditure Index? PCE Price Index