Chartered Financial Analyst (CFA) Practice Exam Level 2

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What is the implication of a lower PEG ratio?

Higher cost for growth

Paying less for each % growth

A lower PEG ratio indicates that an investor is paying less for each percentage of earnings growth expected from a company. The PEG ratio is calculated by taking the price-to-earnings (P/E) ratio and dividing it by the expected earnings growth rate. A value below 1 suggests that the stock is undervalued relative to its growth prospects, as investors are essentially getting more growth for a lower price.

This measurement is important because it provides a more nuanced view of a company's valuation by taking into account both its current earnings and its future growth potential. Investors often seek stocks with a lower PEG ratio because it suggests an opportunity for higher returns, as they are essentially buying growth at a bargain price. Hence, for those looking to invest in companies poised for significant growth without overpaying, a lower PEG ratio reflects a favorable valuation.

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Lower growth potential

Higher valuation risk

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