What does the PEG ratio represent?

The PEG ratio, which stands for Price/Earnings to Growth ratio, specifically represents the relationship between a company's Price to Earnings (P/E) ratio and its expected earnings growth rate. This ratio is calculated by taking the P/E ratio and dividing it by the anticipated rate of growth in earnings.

The formula is designed to provide a more complete picture of a company's valuation by not only considering its current earnings relative to its stock price (which the P/E ratio does), but also factoring in how quickly the company is expected to grow in the future. Investors use the PEG ratio to assess whether a stock is overvalued or undervalued based on its growth potential. A PEG ratio of 1 is often considered fair value, indicating that the stock's price is aligned with its growth rate.

The other choices provide different mathematical relationships that do not accurately represent the PEG ratio. For instance, dividing earnings growth rate by the P/E ratio (the second option) or multiplying the P/E ratio by earnings per share (the fourth option) does not convey the same insights regarding valuation relative to growth rates as the PEG ratio does. The third choice mischaracterizes the ratio altogether by shifting the focus away from the P/E ratio's relationship with growth rates.