Price-to-Earnings-to-Growth and Dividend Yield Ratio

See: Price-to-Earnings-to-Growth Ratio. See: Dividend Yield.

A law firm that recruited too many partners? A really boring double play combo?

Actually, it's a way to track how a company gets valued by the equity markets. The basic measure of valuation is called price-to-earnings ratio (also known as the P/E ratio). That figure takes a company's stock price and compares it to the amount the firm posts in earnings. The higher the ratio, the more the stock purchaser has to pay for the earnings the firm produces. The higher the price-to-earnings ratio, the higher the company's growth has to be to justify the cost.

PEGY takes the comparison a step further than a simple P/E ratio. It integrates the firm's dividend yield as well. So now...you're not only measuring how much earnings you get from a company, but the amount of cash the firm pays out in a dividend as well.

The PEGY ratio takes into account a basic dichotomy. There are two fundamental ways an investor makes money on an equity investment: capital appreciation or dividend payments. Either you buy low and sell high, or you get cash payments from the company (the firm distributing a portion of its profits to shareholders in the form of dividends). Cutting edge industries (drug development, tech startups, etc.) tend to aim for capital appreciation. You'll buy the stock now at $5 a share and, in five years, sell it for $500. Mature industries rely more on dividends. You don't expect a big appreciation in the stock's price over time (a slow, Steady Eddie increase would be nice), but in exchange for a lower possible stock price appreciation, you get stability (a lower chance at a big drop) and a dividend payment.

The PEGY ratio tries to put these companies on the same footing, so its easier to compare them. Start with the firm's P/E ratio. (To calculate this, divide its share price by the earnings per share it posts.) Then divide the P/E ratio by the company's projected growth rate and its dividend yield. The result represents the PEGY for that equity.

Some companies might have high growth and low (if any) dividends. Others might have low growth and high dividend rates. Yet another class of companies might split the difference between the two. The PEGY gives you a basis of comparison.