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The PEG ratio compares a stock price/earning (P/E) to its expected EPS (Earning Per Share) growth. If a company’s stock has P/E 20, and its EPS is expected to grow 20%, then PEG will be 20/20 = 1. PEG equals one, means that it has fair value not undervalue nor overvalue.

PEG can help investor in finding low valued stock. If PEG lower than 1, it is possibly a sign of undervalued stock. In addition, if PEG is greater than 1, it might indicate that the stock is overvalued. Growth stock usually has PEG greater than 1 because it is expected to have high growth. Always remember to compare PEG and other ratio with other companies which are in the same industry and preferable the same size.
The hard thing when using PEG is getting the EPS growth. We can’t predict EPS growth accurately, although companies usually set the companies growth target. Anything can happened in the future, so PEG might be misleading.

Nowadays, many company buy back their stock from the market. When the market fall causing the stock price fall, and management thinks that the company has good fundamental, they will “buy back”. Stock buyback, also known as “share repurchase”, is a company’s buying back its shares from the marketplace. The company buy its own shares, making the number of outstanding shares on the market is reduced. Buyback will have this implication:

• Buyback will make the relative ownership of each investor will increase because there are fewer shares. So if you have Microsoft stock and the company buyback its stock, then your ownership to the company will rise.
• Buyback will change financial ratio. A buyback will increase return on assets (ROA) because cash (asset) is used to buyback stock. Return on equity (ROE) will increase because there is less outstanding equity. Earning Per Share (EPS) will increase because the number of outstanding stock decrease, thus the Price-Earning Ratio (P/E) will decrease. The lower the P/E, the better it is.

Why company buyback their stock?

• The company want to maximize return for shareholders. Remember the increasing ROE and ROA.
• The company thinks that current stock price is too low. Thus, when a company buying its own shares, it says management believes that the market has gone too far in discounting the shares, which means its a positive sign to the investor.
• The company wants to reduce dilution caused by employee stock option plans (ESOP). Giving ESOP means making more available stocks, lowering ROA and ROE. ESOP and buyback have the opposite effect.
• The company thinks that, it’s the best way to use their money at a particular time.

We can’t tell that a buyback is good or bad? But by knowing the company motives behind this buyback, we’ll know whether this is good or not. Beware for company using buybacks just to increasing the financial ratios, without better performance from the company. A poor company may do buyback to give positive signs to investor. Therefore the signs may not show the real outlook of the company.

To find a cheap stock you need to know its fair value. It the current price is lower than its fair value, then you got your self a cheap stock. Cheap stock does not mean it has low dollar value. A $100 stock is called cheap if its fair value is $200, grater than it’s current price. A $1 stock is called expensive if its fair value is
$0.5, lower than it’s current price. A simple way to find out if a stock is cheap or not is by looking at it’s P/E (Price / Earning) ratio. The P/E ratio is a measure of the price paid for a share relative to the profit per share.

A higher P/E ratio means that investors are paying more for each unit of income. The price per share (numerator) is the market price of one stock. The earnings per share (denominator) is the net income of the company for the most recent 12 month period, divided by number of shares outstanding. Investors can use the P/E ratio to compare the value of stocks. If one stock has a higher P/E that of another stock in the same industry, all things being equal, it is a less attractive investment. Normally, stocks with high earning growth are traded at higher P/E values, because investor anticipate the high growth.

A more advance ratio fom PE is the PEG ratio. The Price/Earnings To Growth, is a valuation metric for determining the relative trade-off between the price of a stock, the earnings generated per share (EPS), and the company’s expected growth. A lower ratio is “better” (cheaper) and a higher ratio is “worse” (expensive). A PEG ratio that approaches two or goes higher than 2 is believed to be too high. This means that the price paid is to be much higher relative to the projected earnings growth.

The PEG ratio of 1 represents a fair value between the price and the company’s growth. Similar to PE ratios, a lower PEG means that the stock is undervalued more. If a company is growing at 30% a year, then the stock’s P/E could be 30 to have a PEG of 1. PEG ratios between 1 and 2 are therefore considered to be in the
range of normal values.

Defining the projected growth rate is difficult. It will be wise enough to use reasonable future growth rate by checking quarter’s earnings have grown, as a percentage, over the same quarter one year ago. PEG ratio is use suitable for high growing company and is less appropriate for measuring companies without high growth. Large, well-established companies, for instance, may offer dividend income, but little growth. This dividend will affect price and PEG ratio. PEG is a widely used indicator of a stock’s potential value. It is favored by many over the price/earnings ratio because it also accounts for growth. Similar to the
P/E ratio, a lower PEG means that the stock is more undervalued. Keep in mind that the numbers used are projected growth and therefore can be less accurate.