Chartered Financial Analyst (CFA) Practice Exam Level 2

What does the PEG ratio help investors assess?

1. Value per share

2. Growth rates in relation to price

3. Debt-to-equity ratios

4. Current ratio of the firm

The correct answer is: Growth rates in relation to price

The PEG ratio, which stands for Price/Earnings to Growth ratio, is a valuable metric that helps investors assess the relationship between a company's price-to-earnings (P/E) ratio and its expected growth rate. By comparing the P/E ratio of a stock to the anticipated growth rate of its earnings, investors can gain insight into whether a stock is overvalued, undervalued, or fairly priced. A PEG ratio below 1 may suggest that the stock is undervalued in relation to its growth potential, making it an attractive investment opportunity. Conversely, a PEG ratio above 1 could indicate the stock is overvalued, suggesting investors are paying too much for the expected growth. This ratio provides a more nuanced view than the P/E ratio alone, allowing investors to consider growth expectations when making their assessments. In contrast, the other options do not accurately capture the primary function of the PEG ratio. Value per share pertains more to traditional valuation metrics, while debt-to-equity ratios and current ratios are liquidity and solvency metrics, respectively. None of these options relate to the specific focus of the PEG ratio on growth in relation to price.