What Is Price/Earnings to Growth and Dividend Yield (PEGY Ratio)?
The price/earnings to growth and dividend yield (PEGY ratio)—also known as the "dividend-adjusted PEG ratio"—was created by famed value investor Peter Lynch. By creating the PEGY ratio, Lynch sought to improve upon the price-to-earnings (P/E) valuation metric most investors use when trying to determine the value of a stock.
Lynch believed that in order to accurately evaluate the opportunity a stock represents as an investment, the investor should also factor in the stock's future growth prospects and dividend yield. The PEGY ratio includes both of these factors and is a metric investors use to identify undervalued stocks.
- The price/earnings to growth and dividend yield (PEGY ratio) was developed by Peter Lynch, a legendary investor and fund manager.
- As a metric for stock analysis, the PEGY ratio differs from the price-to-earnings (P/E) ratio because it takes into consideration the stock's potential for future earnings growth and dividend payments.
- A PEGY ratio below 1.0 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.
Understanding Price/Earnings to Growth and Dividend Yield (PEGY Ratio)
Both the PEGY ratio and the price/earnings-to-growth (PEG Ratio) are evolutions of the price-to-earnings (P/E) ratio. One limitation Lynch realized when using the P/E and PEG ratios for stock evaluation was that these metrics did not take the potential for future earnings growth or dividend payments into consideration when analyzing the stock.
Because of this, mature companies with a lower growth rate that pay dividends were unfairly punished if they were only evaluated using the P/E or PEG ratios. Lynch wanted a more accurate way of evaluating these companies and thus created the PEGY ratio that added projected growth and dividend yield into the equation.
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 = Projected Earnings Growth Rate and Dividend YieldEP Ratio
Example of Price/Earnings to Growth and Dividend Yield (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 = 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
It's important to note the PEGY ratio has its drawbacks. It uses the company's projections for growth and not the actual growth the company achieves. Therefore, the ratio isn't guaranteed to be an accurate reflection of future performance.
When calculating any of these ratios, it is always a good idea to use only operating and recurring income in the calculation of earnings, to use a lower consensus estimate for the growth rate, and to use projected future dividends as opposed to current dividends. While the PEGY ratio doesn't tell the whole story of a stock's potential for appreciation, it provides investors with a starting point in their stock analysis.