Definition and Examples
The Dividend-Adjusted Earnings Growth Rate (PEGY) is a ratio derived from the Price/Earnings Growth (PEG) ratio. It takes into account the dividends distributed to investors when evaluating stocks.
How to Calculate the Dividend-Adjusted Earnings Growth Rate
The necessary information to calculate the Dividend-Adjusted Earnings Growth Rate can be obtained from the company’s published financial statements or stock listings (if it is a publicly traded company). For example, Company CDF may have annual dividends of $1.64 per share and a current share price of $54.84.
Using CDF’s information, you can calculate the Dividend-Adjusted Earnings Growth Rate using the following formulas. First, calculate the dividend yield:
The dividend yield for CDF will be 2.9% (1.64 ÷ 54.84).
If CDF’s financials are available, you can use their data to determine the earnings growth per share:
If the earnings per share in 2020 were $0.64, and in 2019 they were $0.39, then the earnings growth per share for 2020 will be 64%.
Use the Dividend-Adjusted Earnings Growth Rate formula to determine the PEGY ratio for CFD. From the provided financial information, the price-to-earnings ratio for CFD in 2020 was 8.32. Add the earnings growth to the dividend yield, and divide the price-to-earnings ratio by the result:
The PEG ratio for CDF in 2020 was 11.9, while the Dividend-Adjusted Earnings Growth Rate for 2020 was 2.35. If the PEGY ratio is less than 1, it is considered a good investment based on growth and earnings; CDF may not be the first choice for investors looking for high growth and rewards.
How the Dividend-Adjusted Earnings Growth Rate Works
When a company is large and very profitable, it returns profits to its shareholders in the form of cash dividends. This can lead to a situation where the company appears to be growing slowly.
Note: In addition to earnings growth per share, shareholders receive dividends. When this happens, the PEG ratio alone is insufficient, as the overall attractive stock may appear overvalued, which may not be accurate.
In these cases, the PEG ratio does not work well, because a stock with a high PEG ratio may generate an attractive total return. When analyzing most high-quality and well-known stocks, such as Procter & Gamble, Colgate-Palmolive, Coca-Cola, and Tiffany & Company, you are likely to need to use the Dividend-Adjusted Earnings Growth Rate.
Limitations of the Dividend-Adjusted Earnings Growth Rate
Like any other ratio used when analyzing a stock, the Dividend-Adjusted Earnings Growth Rate is not a reliable method of evaluation on its own. It should be used in conjunction with other methods to generate a comprehensive view of the company’s stocks and performance. This view comes from analyzing the income statement, balance sheet, and cash flow statement, taking into account external factors such as the state of the economy or the company’s position within its industry.
Another problem that both inexperienced and expert investors tend to face when using a financial measure such as the Dividend-Adjusted Earnings Growth Rate is the intrinsic human tendency to be overly optimistic about the future earnings growth rate of a stock.
Key Takeaways
The Dividend-Adjusted Earnings Growth Rate considers earnings and provides a more accurate picture of company growth. PEGY should be used during financial analysis to get a company overview using multiple ratios. Like all other financial ratios, PEGY is not an indicator of future performance but is used to assess what might happen.
Source: https://www.thebalancemoney.com/dividend-adjusted-peg-ratio-357146
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