 # Price to Earnings Growth for Beginners [Explained]

hey guys what is up welcome back to my
channel if you guys have been watching my past few videos you guys will know
the importance of understanding and using financial ratios in determining
the financial strength of companies and also how these financial ratios can
indicate whether the company is fairly valued or overvalued if you want to be
able to analyze a company’s financial strength then you need to learn how to
analyze a company’s financial ratios amongst other things as well as learn
how to use these financial ratios to compare the financial strengths of
companies against its competitors so in this video today I’ll be sharing with you guys about the price to earnings growth ratio and explaining what it
means how to calculate the price to earnings growth ratio and how to use the
price to earnings growth ratio with that let’s go onto my computer okay I’m on my
computer so let’s take a look at what a PEG ratio means the price to
earnings growth ratio or PEG ratio is calculated by taking the price earnings
ratio divided by the growth rate of earnings of a company over a specific
period of time if you are unsure of how to calculate the price earnings ratio
of a company and what it means you can click on the link on the top right of
your screen to watch my video over there so the price to earnings ratio divided
by the growth rate of earnings will give us the price to earnings growth ratio of
a company the PEG ratio is also used to determine the value of a company and it
is considered to provide a more complete picture than the p/e ratio as
it factors in the earnings growth rate of a company so what does this mean
Linus okay so for example if we have two companies Company A and Company B so
both companies are in the technology sector and business software and
services industry so both companies are in the same sector and same industry so
let’s say Company A has a p/e ratio of 25 and Company B as a p/e ratio of 20 so
solely based on the p/e ratio of Company A and B we will say that Company B is
more fair value than Company A and Company B represents better value
for us investors so if we solely compare the p/e ratio of these two companies
then Company B is said to be more fair value than Company A because Company B
has a lower p/e ratio however the picture changes when we take into
consideration of the company’s earnings growth rate so if Company A has an
earnings growth rate of 15% and if Company B has a earnings growth rate of
5% in this case Company A has a highest higher earning growth rate compared to
Company B so a higher earnings growth rate means that company A is expected to
increase it’s earnings per share by a greater extent than Company B in the future so
what this means for us investors and traders then is that we are likely to
earn more money and returns if we own one share of Company A compared to owning
one share of Company B so since we as investors and traders are likely to earn
more from one share of Company A compared to Company B the higher
earnings growth rate of Company A can justify its higher p/e
ratio to a certain extent so why is this so because investors and
traders tend to reap greater potential capital gains or greater increase in
their stock prices in the future therefore more investors and traders are
likely to want to buy Company A for its potential earnings and therefore the
price and PE ratio of Company A is likely to be more overvalued than
Company B so by using a PEG ratio which takes into account the earnings growth
rate of a company it can give us a fairer indication of the value of the
companies so if you want to calculate the PEG ratio of Company A we
take the price earnings ratio which is 25 for Company A divided by its earnings
growth rate of 15% which will give you a PEG ratio of 1.67 and to
calculate the PEG ratio for Company B we take the p/e ratio of Company B which is
20 divided by its earnings growth rate which is five percent
so we get a PEG ratio of 4 so okay that’s a lot of information to take in
right there so some of you might be able to take all of it in the first
time some of you may not so if all you guys who didn’t manage to catch it the
first time it’s alright because back when I first started I also didn’t
manage to catch it the first time so what you can do is you can pause
this video here and rewatch that part and watch this video a few times to
really get hold and understand the principles behind it so the PEG ratio
gives us a fairer indication of the value of a company compared to the PE
ratio and we want the PEG ratio of a company to be low the lower the better
so when the PEG ratio of a company is low it can indicate that a stock is
undervalued or at least not overvalued so as with other financial ratios there
are no hard and fast figures of what constitutes a good figure so sure any
figure below 1 is ideal because that means the earnings growth rate of a
company is higher than the price to earnings ratio which makes a company
fair and undervalued however we always want to take the PEG ratio into context
and one way to do that is by comparing the PEG ratio of companies with its
competitors in the same industry and sector so of course we have to compare
the PEG ratio of companies with its competitors to gain a fuller picture so
quick tip when comparing financial ratios of company we always want to
compare them with other companies in the same sector and ideally in the same
industry okay so we have covered how to calculate the PEG ratio and how to use a
PEG ratio so let’s head over and take a look at some real-life examples alright
so I’m on Finviz right now so Finviz is a financial website where we can
get the financial data of companies so let’s take a look at some companies okay
so for the first company we’ll take a look at is Facebook so as you can see we
have the financial data for Facebook right here
we have the price to earnings we also have the PEG ratio so how do we
calculate the PEG ratio to get 1.51 so remember we
learned in the earlier slides there we want to first take the price earnings
ratio which is 31.94 in this case so we key in 31.94 in my calculator divided by the earnings growth rate so where do
we find the earnings growth rate so when we want to find that earnings growth rate
we always take the earnings growth rate for the next five years as the benchmark
so in this case we want to take the earnings per share for the next five
years so in this case the earnings per share for Facebook for the next five
years is 21.2% so we key that down 21.2% so what we get will be 1.51 so let’s double check see so we have the exact same figure as the figure
provided by the website so the PEG is 1.51 so again how do we get
the PEG ratio of Facebook to get 1.51 we take the price
earnings of Facebook which is 31.94 divided by the earnings
per share for the next five years which is 21.2 so if you take
31.94 divided by 21.2 you’ll
get 1.51 okay so let’s take a look at another example let’s
take a look at Alibaba okay so alibaba’s price to earnings ratio is 54.46 so let’s key that down in the calculator so it’s 54.46 divided by the earnings per share for the next five years so the
earnings per share again for the next five years indicates the earnings
growth rate so for alibaba’s earnings per share for the next
five years is 3.66% so we key that down 3.66% so you’ll get a value of 14.9 so let’s double
check whether we got the correct value so as you can see PEG is
14.88 we got 14.9 or we
also got the same figure 14.88 because we round it up to one
decimal place they round it up to two decimal place so as you can see
that’s how we calculate the PEG ratio that is it for the YouTube
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is it with the youtube video i’ll see you guys soon to your financial success 