— -- Q: Why is Google's goog PEG ratio below 1?
A: You are probably familiar with a price-to-earnings or P-E ratio. The PEG ratio is a little more specialized.
A P-E ratio tells you how much investors are paying for a claim on $1 of a company's earnings.
For instance, if a stock has a P-E of 15, investors are paying $15 for every $1 in the company's per-share earnings. You can learn more about how to calculate a stock's P-E ratio here.
The PEG ratio (price-earnings to growth ratio) attempts to take the P-E to the next level. It's a way to compare a P-E to a company's expected growth rate.
The PEG is essentially a stock's P-E divided by its expected growth rate. You can learn more about how the PEG is calculated here.
Now that you see what a PEG tells you, you can consider Google. Google's stock price was around $340 a share last week. To get the forward P-E ratio, divide that share price by the $21.20 a share the company is expected to earn in 2009. The resulting P-E is 16.
To derive the PEG, divide the 16 forward P-E by the expected long-term growth rate of 18.4%, from Thomson Reuters. The resulting PEG is 0.86. So you're right, Google's PEG is less than 1. That's interesting because investors, as a rule of thumb, consider stocks to be cheap if they have a PEG of less than 1 or even 1.5.
Why is Google's PEG low? There are two possible reasons. Either Google stock is undervalued, or, Wall Street's estimate for the company's growth is too high.
The problem is there's no way to know for sure which one is the case. A growth rate of 18.4% is pretty aggressive for a company that's already as large as Google.
Matt Krantz is a financial markets reporter at USA TODAY and author of Investing Online for Dummies. He answers a different reader question every weekday in his Ask Matt column at money.usatoday.com. To submit a question, e-mail Matt at firstname.lastname@example.org. Click here to see previous Ask Matt columns.