Investors are always looking for tools to thin the thousands of available stocks down to manageable numbers for further research. The price to earnings to growth (PEG) ratio is widely used to screen for stocks that may be undervalued by the market. Use a stock screener and your desired PEG parameters to generate a list of potential stock investments.
The PEG ratio is an expansion on the price to earnings (P/E) ratio. The P/E ratio divides the share price of a stock by the most recent earnings per share. The P/E ratio of every stock is included with the price quote on the major financial websites. The PEG ratio further defines the P/E ratio by dividing the P/E by the forecast five-year annual growth rate. The PEG relates a stock's valuation to its forecast rate of growth. For example, a stock with a current P/E of 20 is forecast to grow earnings at 20 percent per year. The P/E divided by the growth rate gives a PEG ratio of 1.00.
The P/E ratio of a stock is a comparative value of the stock and stocks with high growth rates typically have high P/E ratios. The PEG ratio quantifies this relationship between stock value and earnings growth. A stock with a PEG of less than 1.00 has a forecast earnings growth rate higher than what is indicated by the P/E ratio. A PEG greater than 1.00 indicates a stock where the market is putting a higher value on a company's projected growth. The PEG value of 1.00 is often used as a cutoff when looking for undervalued stocks.
A stock screener is a software program or online tool that allows investors to select a list of criteria for stock investments -- the screener will provide a list of stocks that meet those criteria. Screening criteria can include market cap, industries, index membership and a wide range of financial data points. Many screeners include the PEG ratio as one of the criteria available for use. Major financial websites and online brokerage accounts provide access to a stock screening tool.
Screening with PEG
Set up a stock screen using the PEG ratio plus any other stock criteria you want to include. For example, a simple screen for stocks with market caps greater than $5 billion, projected earnings growth rates greater than 15 percent and a PEG below 0.7 produces a list of about 80 stocks. The screen can be fine tuned by changing criteria or adding more criteria. In the example, if the screen is limited to stocks trading on the NASDAQ, the number of stocks shrinks to 12. These stocks could then be evaluated for investment potential.