What is a Price/Earnings-to-Growth and Dividend Yield Ratio (PEGY)?
The price/earnings-to-growth and dividend yield ratio (PEGY) demonstrates how much the market is willing to pay for earnings growth and dividend yield. By incorporating dividend yield, the PEGY ratio accounts for a companies' inclination (or disinclination) to pay out dividends.
How Does a Price/Earnings-to-Growth and Dividend Yield Ratio (PEGY) Work?
The formula for the PEGY ratio is:
PEGY = (Price / EPS) / (Earnings Growth Rate + Dividend Yield)
note that earnings growth rate and dividend yield are expressed in whole-number rather than decimal form (i.e., '10' for 10%, rather than 0.10).
For example, let's consider Company XYZ, which had $0.50 of earnings per share (EPS) last year and currently has a stock price of $2. The company is expected to grow earnings by 15% this year. Company XYZ currently pays a $0.20 dividend per share.
Using this information and the formula above, we can calculate Company XYZ's PEGY as:
PEGY = ($2 / $0.50) /(15 + 10) = 4/20 = 0.16
Note that to get the dividend yield, we simply divide the dividend per share by the stock's price per share (0.20 / 2.00) = 10%
Why Does a Price/Earnings-to-Growth and Dividend Yield Ratio (PEGY) Matter?
Low PEGY ratios (below 1.0) tend to suggest that a stock is 'cheap,' but has high earnings potential or dividend yields. Thus, a stock with a low PEGY ratio might be poised for significant price appreciation. REITs and other companies that tend to be valued according to their funds from operations rather than their earnings might have high PEGY ratios and still be 'cheap.'
It is important to note, however, that the PEGY ratio is based on expected growth rather than actual growth. It is also important to note that PEGY ratios vary among industries, and thus defining a high or low ratio should be done within this context.