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PEG Payback Years

The number of years it would take for a company's cumulative earnings (beginning at a base level of $1.00) to equal the stock's current P/E ratio , assuming that the company continues to increase its annual earnings at the growth rate used to calculate the PEG ratio. A PEG payback period of six years, for example, means that it would take six years for an investor to recoup the price paid now for $1 of corporate earnings (the P/E ratio).

Equivalently, the PEG payback period is the number of years it would take for the cumulative earnings of a company (based on the forecast of future earnings growth used to calculate the PEG ratio) to equal the current price of the stock. In other words, the PEG payback period is the amount of time it would take for the company to "earn" its stock price.

Benefit

The higher the PEG Payback, the longer the company will take to earn the equivalent of its stock price. A high PEG Payback may indicate a stock where the risks are high that the company will fail to generate the earnings necessary to support its valuations.

For the Pros

Here's the calculation:

  1. Starting with $1.00, project earnings on a year-by-year basis using the projected earnings growth rate: Year 1=$1.00, Year 2=$1.00 * 1.X, Year 3=Year 2*1.X, and so on, where X is the company's projected earnings growth rate expressed as a decimal.

  2. Add the figures for each year until the sum equals the P/E ratio.

  3. The point at which cumulative earnings equal the P/E ratio is the PEG Payback Period.

Example

 Suppose a company has a P/E of 10 and a projected five-year earnings-growth rate of 20%.

The company's cumulative earnings, setting year one's earnings equal to $1.00, are: Year 1=$1.00 + Year 2=$1.20 + Year 3=$1.44 + Year 4=$1.73 + Year 5=$2.07 + Year 6=$2.49 = $9.93. This figure is pretty close to the P/E of 10, so the payback period is six years.