The dividend-adjusted price-to-earnings-growth ratio (PEGY) is a ratio derived from the price-to-earnings-growth ratio (PEG). It accounts for dividends paid to investors when they valuate stocks.
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 growth measures the value of a stock 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 has to be used.
To get an idea of how the PEGY works, assume 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 one 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 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 per share of $1.64 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 the data from them to determine earnings per share growth:
If earnings per share for 2020 was $.64, and for 2019 it was $.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 one 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 addition to the earnings-per-share growth, stockholders are receiving dividends. When this is the case, the PEG ratio alone is not sufficient because it will appear that an otherwise attractive stock is significantly overvalued, which may not be accurate.
In these situations, the PEG ratio doesn't work well because stocks with high PEG ratios might generate an attractive total return. The odds are good when you analyze most high-quality blue-chip stocks such as Procter & Gamble, Colgate-Palmolive, Coca-Cola, or Tiffany & Company 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, 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 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.
- The dividend-adjusted PEG ratio accounts for dividends and provides a more accurate picture of a company's growth.
- The PEGY should be used during a financial analysis to gain a picture of the company with multiple ratios.
- Similar to all other financial ratios, the PEGY is not an indicator of future performance but is used to evaluate what could happen.