What it means
The price-to-earnings (P/E) ratio shows how much investors pay for each dollar of profit. A high P/E may mean a high price, but it may also reflect fast growth.
The PEG ratio fixes this by dividing the P/E by the expected growth rate. The PEGY ratio adds a second adjustment.
Some companies grow slowly but pay generous dividends, and the PEG ratio would make them look expensive. By adding the dividend yield (annual dividends divided by the share price) to the growth rate, PEGY recognises that shareholders earn from both.
The formula is simple. Divide the P/E ratio by the sum of the growth rate and the dividend yield, both expressed as whole-number percentages.
For example, a P/E of 15 with 10% growth and a 2% yield gives 15 divided by 12, which is 1.25. Investors often treat a PEGY below 1 as a sign that a stock may be undervalued, and a figure well above 1 as a sign that it may be expensive.
These are rough guidelines rather than strict rules. The best use is to compare similar companies in the same industry, where growth and risk are comparable.
The measure is especially helpful for mature companies such as utilities, banks and consumer goods firms, where dividends are a big part of the return. For young technology firms that pay no dividend, PEGY is the same as PEG.
It is therefore a sensible tool when comparing a dividend payer with a non-payer. Like all ratios, it has weaknesses.
The growth rate is a forecast and can be wrong, and the measure ignores debt, cash flow quality and risk. A company can also pay a high dividend it cannot sustain, so the yield should be checked against earnings and cash generation.
In practice
Real-world examples.
Example
An income-focused investor compares two utilities. One has a PEGY of 1.4 and the other 0.9, so she studies the second in more detail, checking that its dividend is covered by earnings.
Example
A fund analyst screens consumer goods stocks. A company with a P/E of 18, growth of 6% and a yield of 4% has a PEGY of 18 / 10 = 1.8, which is higher than its peers, so she marks it as expensive.
Example
A private investor owns a bank with a P/E of 9, growth of 5% and a yield of 4%. The PEGY is 9 / 9 = 1.0, which she takes as a sign that the shares are fairly priced.
Formula
Calculation
PEGY = P/E ratio / (Expected annual earnings growth rate in % + Dividend yield in %)
Suppose Stock A trades at $60, earns $4.00 per share and pays a dividend of $1.20 per share. Its P/E is 60 / 4 = 15. The dividend yield is 1.20 / 60 = 2%. Expected earnings growth is 10% a year. PEGY = 15 / (10 + 2) = 15 / 12 = 1.25. Its PEG ratio, without the dividend, would be 15 / 10 = 1.5. Stock B has the same P/E of 15 but 8% growth and a 5% yield, so its PEGY is 15 / (8 + 5) = 15 / 13 = about 1.15, which looks slightly better value than Stock A.Case study
Seen in the real world.
Elmstead Asset Partners is an illustrative, fictional firm that screens stocks for a retirement fund. It ranked a group of supermarkets using PEG and found that the slowest growers looked the most expensive, with PEG ratios above 2.
The analyst added dividend yield and re-ranked by PEGY. One supermarket with a P/E of 14, growth of 4% and a yield of 5% moved from a PEG of 3.5 to a PEGY of 14 / 9 = about 1.6, putting it in the middle of the group.
The fund bought a small holding, after checking that the dividend was covered twice by earnings. The illustrative lesson is that ignoring income can make steady dividend payers look worse than they are.
Watch out
Common mistakes.
- Entering growth and yield as decimals in one place and percentages in another, which gives a wrong ratio.
- Treating a PEGY below 1 as a guaranteed bargain, when the growth forecast may be too optimistic.
- Ignoring whether the dividend is sustainable, since a high yield can come from a falling share price.
Questions
People also ask.
How is PEGY different from PEG?
PEGY adds the dividend yield to the growth rate in the denominator, so dividend payers are not penalised.
What is a good PEGY?
Many investors look for values below 1, but comparing companies in the same industry matters more than a single cut-off.
Which growth rate should I use?
Usually the analysts' consensus forecast for annual earnings growth over the next three to five years, with a sense check against history.
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