There may be good reasons to believe that future growth will slow or quicken. While this may be appropriate in some cases, an investor should consider whether past growth rates are indicative of a companyвЂ™s future prospects. One can base a growth estimate on past growth rates. Rate of GrowthДЄs with future earnings, a future growth rate requires estimates. This approach results in what Warren Buffett calls вЂњownerвЂ™s earnings.вЂќ OwnerвЂ™s earnings reflect the fact that a company may need to use some of its profits to replace machinery, computer systems, or other equipment just to maintain its current level of operations. One approach is to adjust reported earnings for any capital expenditures required to maintain the business. As a result, using an estimate of future earnings can add more uncertainty to the results.Д«eyond using TTM or future earnings, one must also consider whether to make any adjustments to a companyвЂ™s reported earnings. While this approach may better reflect the companyвЂ™s current position, it does require an estimate.

The potential disadvantage is that past earnings may not reflect the companyвЂ™s future prospects.ДЄs a result, some investors prefer to use the consensus estimate of a companyвЂ™s earnings over the next year. Past earnings are reported in the companyвЂ™s financial statements. The advantage of this approach is that it doesnвЂ™t require an estimate.

The first is to use a companyвЂ™s earnings from the past year, commonly referred to as TTM, for trailing twelve months. There are two general approaches to earnings. The complexities arise from attempts to estimate earnings per share and growth. The price of a stock is its current market price, which doesnвЂ™t require an estimate. To calculate the PEG ratio, an investor needs three things: As simple as the math is, there are complexities to the PEG ratio. One simply divides a companyвЂ™s P/E ratio by its expected rate of growth.ДЄ company with a P/E ratio of 20 and an expected growth rate of 10%, for example, would have a PEG ratio of 2 (20 / 10). The math behind the PEG ratio is straightforward. The PEG ratio can help an investor put a price on a companyвЂ™s rate of growth. A вЂњgrowth at any costвЂќ approach can result in paying too much even for a great company. The question remains, however, how much an investor should be willing to pay for growth. Investors are willing to pay more for potential growth: When they see the potential for growth, high near-term prices arenвЂ™t necessarily a problem. Growth companies tend to have higher P/E ratios than value companies for this reason. A company thatвЂ™s expected to grow its revenue, earnings and cash flow at a high rate is, all other things being equal, more valuable than a company with little growth opportunity. The PEG ratio compares a companyвЂ™s P/E ratio to its expected rate of growth,В a key factor for assessing its value. The PEG ratio can provide a more complete picture of whether a stock is overvalued or undervalued. Compare the PEG ratio to the price-to-earnings ratio (P/E ratio), a related measure that evaluates how expensive a stock is by comparing the companyвЂ™s stock price to its earnings. The price/earnings-to-growth ratio, or the PEG ratio, is a metric that helps investors value a stock by taking into account a companyвЂ™s market price, its earnings and its future growth prospects.

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