Learn how to calculate the dividend-adjusted PEG and how to interpret the results.
Definition and Examples of the Dividend-Adjusted PEG
Price-to-earnings-to-growth measures the value of a stock as compared to its growth rate. When dividends (or yields) are added to earnings growth, the PEG changes. When dividends are accounted for in a large corporation’s PEG, the result is a more accurate growth indicator. If a business doesn’t distribute earnings to shareholders, the non-adjusted PEG must be used. To get an idea of how the ratio works, suppose company ABC has a P/E ratio of 9.1, projected earnings growth of 3%, and a PEG ratio of 3.03. When its dividend yield of 2.1% is accounted for, it has a PEGY of 1.78. This demonstrates that ABC’s stock is cheaper than its PEG ratio shows, because the ratio accounts for the money an investor gets back in the form of a dividend. A PEGY ratio of less than 1 indicates a stock has a high dividend yield, is likely to grow, and is priced low.
How Do You Calculate the Dividend-Adjusted PEG?
The information you need to calculate the dividend-adjusted PEG can be acquired from a business’s published financial sheets or stock listings (if they are a publicly traded company). For example, CDF Company could have annual dividends of $1.64 per share and a current share price of $54.84. Using CDF’s information, you can calculate its PEGY using the following formulas. First, calculate its dividend yield: CDF’s dividend yield would be 2.9% ($1.64 ÷ $54.84). If CDF’s financial statements were available, you could use their data to determine earnings-per-share growth: If earnings per share for 2020 were $.64, and for 2019 they were $.39, earnings-per-share growth for 2020 would be 64%. Use the dividend-adjusted PEG ratio formula to determine CFD’s PEGY ratio. From the financial information provided, CFD’s price-to-earnings ratio for 2020 was 8.32. Add the EPS growth to the dividend yield, and divide the P/E by the result: CDF’s PEG ratio for 2020 was 11.9, while the dividend-adjusted PEG ratio for 2020 was 2.35. If a PEGY of less than 1 is considered a good investment based on growth and dividends, CDF might not be an investor’s first choice if they are looking for growth and high rewards.
How the Dividend-Adjusted PEG Ratio Works
When a company is very large and profitable, it returns earnings to its stockholders in the form of a cash dividend. This can result in a situation where the company appears to be growing slowly. In these situations, the PEG ratio doesn’t work well, because a stock with a high PEG ratio might generate an attractive total return. When you analyze most high-quality blue-chip stocks, such as Procter & Gamble, Colgate-Palmolive, Coca-Cola, or Tiffany & Company, the odds are good that you will need to use the dividend-adjusted PEG ratio.
Limitations of the Dividend-Adjusted PEG Ratio
Similar to every other ratio used when analyzing a stock, the dividend-adjusted PEG ratio isn’t a reliable method of valuation on its own. It must be used in conjunction with other methods to generate a holistic view of the company’s stock and performance. This view comes from analyzing an income statement, a balance sheet, and the statement of cash flows while accounting for external factors such as the state of the economy or a firm’s standing within its industry. Another problem that inexperienced investors and experts alike tend to run into when using a financial measurement such as the dividend-adjusted PEG ratio is the innate human tendency to be overly optimistic about the future growth rate of earnings per share.
