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P/E Ratio, PEG

Price/Earnings Ratio

Fundamental analysts look at many variables to evaluate the performance of stocks they are considering buying. The Price/Earnings Ratio (P/E) is one of the more important indicators of performance. It is easily calculated by dividing the stock price by the earnings per share (EPS). An equivalent calculation is to divide the stock's market capitalization by the ater-tax earnings for the last four quarters (trailing P/E). A forward P/E can be estimated by dividing the stock's market capitalization by an estimate of the after-tax earnings for the next four quarters or equivalently dividing the current share price by the estimated EPS for the next year. This ratio shows what investors are willing to pay for each dollar of earnings of the company. Companies which are growing very rapidly can often command high P/E ratios, while slower growing companies warrant smaller P/E ratios. If a company is losing money, it does not have a P/E ratio.

PEG ratio

Another variable that is commonly used by fundamental analysts is the PEG ratio. This is calculated by dividing the P/E ratio by the five-year projected earnings growth rate of the company. For example, if a company has a P/E of 30 and its projected earnings growth rate is 15%, then the PEG = 30/15 = 2. Low numbers (less than one), indicating companies with rapid growth that has not yet been fully reflected in the stock price, can indicate good buys.

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