PEG is alternate growth clue

Q: How can I evaluate fast-growing stocks?

A: The price-to-earnings (P/E) ratio is perhaps the most commonly used metric to evaluate stocks, but it isn’t always useful, especially in cases of rapidly growing companies. For example, shares of Amazon.com cost roughly 240 times earnings as I write this, and Netflix trades for a P/E of 207, although I wouldn’t necessarily call either expensive.

An alternative is the price-to-earnings-growth (PEG) ratio, which takes a company’s growth rate into account. The math is simple enough: Divide the P/E ratio by the expected earnings growth rate going forward, which should be readily available on major financial websites.

Let’s compare Visa and Mastercard. Both trade for approximately 29 times their expected

2017 fiscal year earnings, which looks expensive, but is the same.

This is where the PEG ratio is useful. Visa is expected to grow its earnings at an annualized rate of 17% over the next five years, which translates to a PEG ratio of

1.7. MasterCard is expected to grow at a 15.3% rate, which corresponds to a PEG ratio of about

1.9. Comparing the two shows Visa might be more cheaply valued.

The PEG ratio, like any metric, is just one part of a thorough analysis of a stock. But it can add clarity.

The Motley Fool owns shares of and recommends Amazon, Mastercard, Netflix and Visa.