It’s good when you find a growing company and invest in it. But it’s great when you invest in a growing company at the cheap valuations.
When you shortlist a growing company then it does not mean that you straight forward invest in it at any price.
Rather you should try to find the price levels which are right for the investment.
The valuation metrics
One such metrics which can help you in finding a growing company at cheap valuations is PEG ratio which is Price Earnings to Growth ratio.
It is actually a derivative of PE ratio which can be written as:
The important thing to consider while calculating the Peg ratio is the right and the realistic calculation of the growth rate.
Any unrealistic assumption can make this ratio to give extreme values that are not reliable.
Understanding the concept
Let us understand with the help of an example: The two companies A & B have the following financials:
It is true that PEG ratio is an effective tool to evaluate the stock.
But if it is used in conjunction with other statements like cash flow statement, Revenue growth, and dividend statements, can give wonderful results.