Understanding the PEGY Ratio: Beyond P/E With Growth and Dividends
What Is the Price/Earnings to Growth and Dividend Yield (PEGY) Ratio?
The PEGY Ratio is an enhancement of the traditional price-to-earnings (P/E) ratio, introduced by value investor Peter Lynch. The PEGY addresses the limitations of just using P/E by factoring in both growth potential and dividend yield for a more comprehensive stock evaluation. It’s a metric investors use to identify undervalued stocks.
Key Takeaways
- The PEGY ratio, developed by Peter Lynch, adjusts the PEG ratio by including the potential for earnings growth and dividend yield.
- A PEGY ratio below 1.0 suggests the stock may be undervalued and potentially a good investment.
- The PEGY ratio accounts for future growth prospects and dividend payments, unlike the P/E ratio.
- It evaluates mature companies more accurately by considering their growth and dividends.
- The PEGY ratio uses projected earnings, which may not always reflect actual future performance.
How to Interpret the PEGY Ratio for Stock Valuation
Both the PEGY ratio and the price/earnings-to-growth (PEG Ratio) are evolutions of the price-to-earnings (P/E) ratio. Lynch noted that the P/E and PEG ratios didn’t account for future earnings growth or dividend payments.
As a result, mature companies with lower growth rates and dividends could be unfairly assessed using just the P/E or PEG ratios. Lynch developed the PEGY ratio to evaluate these companies better by including projected growth and dividend yield.
The PEGY ratio is calculated as the P/E ratio divided by the sum of the projected earnings growth rate and the dividend yield, as shown in this formula:
PEGY Ratio
=
P/E Ratio
Projected Earnings Growth Rate and Dividend Yield
text{PEGY Ratio} = frac{text{P/E} text{Ratio}}{text{Projected Earnings Growth Rate and Dividend Yield}}
PEGY Ratio = Projected Earnings Growth Rate and Dividend YieldP/E Ratio
Example: Calculating the PEGY Ratio
Let’s use the PEGY ratio to evaluate a company as a potential investment.
Company ABC has a P/E ratio of 9, a projected earnings growth rate of 15% for the next year, and a dividend yield of 4.5%. Using these numbers, we arrive at the following PEGY ratio:
Company ABC PEGY ratio
=
9
1
5
+
4
.
5
=
0
.
4
6
text{Company ABC PEGY ratio} = frac{9}{15 + 4.5} = 0.46
Company ABC PEGY ratio = 15 + 4.59 = 0.46
A PEGY ratio below 1.0 is considered low and represents a potential investment opportunity as it indicates the stock has high dividend yields or potential growth and is currently selling at a bargain price.
The Bottom Line
The PEGY ratio, developed by Peter Lynch, incorporates both projected earnings growth and dividend yield, thereby offering a more comprehensive evaluation than the P/E ratio alone. A PEGY ratio below 1.0 signals a potential investment opportunity, suggesting the stock is undervalued with high growth potential or dividend yield. Keep in mind that the PEGY ratio is based on projections which might not align with actual future performance, thereby making it a less definitive metric. To account for uncertainties, investors may wish to focus on using operating and recurring income for earnings calculations and lower growth estimates. In addition, consider making the PEGY ratio part of a broader investment strategy that considers multiple data points.