Growth and Dividend Yield (PEGY) Ratio - (01/10/08)

Identifying attractively priced shares which are poised for price appreciation is a tricky task, although the price/earnings to growth and dividend yield (PEGY) ratio offers a relatively reliable strategy.

Today's economic climate has seen record gains and losses for some of the world's most popular shares making any analysis of past trends even more challenging.

In this latest report, IG Index research analyst Anthony Grech looks at the effectiveness of one type of valuation multiple used by professional traders and analysts – the PEGY ratio – to give some explanation of what to look for in your trading research.

Below is a summary of the latest free report from IG Index. You can access the full version in the TradeSense Databank found in the PureDeal platform.

What is the PEGY ratio?

The price/earnings to growth and dividend (PEGY) ratio is one of the most observed multiples in the industry and is derived by dividing a firm's share price by various fundamental data from financial statements. This figure is then compared to those of rival firms or groups with similar financial characteristics to ascertain which company is attractively priced.

Of course there are various issues an analyst needs to bear in mind when using such ratios, including the accounting standards differences between Europe and the US.

A PEGY ratio, which is a modified version of the price-to-earnings ratio, can tell us how many times an investor is willing to pay for each unit of earnings growth and dividend yield. A ratio below 1 means a company is undervalued, while above 1 means it is overvalued.

Utilising the PEGY ratio

Testing the effectiveness of the PEGY ratio on a selection of firms from the S&P 500 produced interesting results. Empirical evidence found that shares with a lower PEGY ratio were no more likely to appreciate in value than those with a higher ratio, but were in fact more likely to fall in the medium-term. The best performing were those with a ratio of between 1.5 and 1.99.

There are various reasons why firms with higher PEGY ratios actually exhibit higher returns, in contrast to several studies showing inferior share price growth, but these results suggest that the PEGY ratio's ability to find high-growth shares in the short-term (around one year) is not effective.

However, the results suggest the ratio could be better used to determine long-term outcomes. Nevertheless, it seems investors should ensure their share price trading strategies are not restricted results from the PEGY ratio alone.

Follow your views

Whatever your views on the future of certain share prices, you are able to take a position with IG Index. We offer prices on all FTSE 100 and FTSE 250 shares*, along with thousands of shares from around the globe.

Read a more in-depth analysis of the PEGY ratio's effectiveness and results from a sample study with our free specialised report from IG Index analyst Anthony Grech, available to all clients. Apply for an account and get set up in minutes.

*Please note: following the FSA's ruling on short-selling banking equities, we currently do not offer short-selling on over 30 UK financial stocks. For detailed information, please see our FAQs.

The above comments do not constitute investment advice and IG Index accepts no responsibility for any use that may be made of them.