Chartered Financial Analyst (CFA) Practice Exam Level 2

Which performance metric combines earnings and growth?

1. Price-to-Earnings Ratio

2. Profit Margin

3. Return on Equity

4. PEG Ratio

The correct answer is: PEG Ratio

The PEG Ratio is a performance metric that effectively combines earnings and growth by relating the Price-to-Earnings (P/E) ratio to the company's earnings growth rate. This ratio provides a more nuanced view of valuation than the P/E ratio alone by factoring in growth expectations, allowing investors to assess whether a stock is overvalued or undervalued given its growth prospects. In essence, a higher PEG ratio may indicate that a stock is overvalued relative to its earnings growth, while a lower PEG ratio might suggest that it is undervalued based on expected growth. This makes the PEG Ratio a useful tool for investors looking to identify growth stocks that are reasonably priced compared to their earnings growth. Therefore, it captures both current earnings performance and future growth potential in one metric, making it a comprehensive tool for evaluating investments. Other performance metrics listed focus more on specific aspects of a company's financials rather than combining both earnings and growth, which makes the PEG Ratio the standout choice for this question.