Ask a Fool: Can I Measure a Company's Growth Potential Based on P/E Ratio?

Worldwide Invest Better Day 9/25/2012

In the spirit of better investing and in celebration of the first Worldwide Invest Better Day coming up on Sept. 25, Motley Fool analysts will be answering user- and reader-submitted questions leading up to the big event. "Ask a Fool" anything, and we'll do our best to help you invest better.

Senior Analyst Anand Chokkavelu responds to the question of how investors should take the price-to-earnings ratio into account when gauging a company's growth value. The P/E ratio is used as an initial way to determine the valuation of a stock, or how cheap it is.

You'd expect to pay more for a company that's going to grow more in the future, while you want to pay less for one without as much growth potential. That's something the P/E ratio doesn't take into account. A better metric to look at is the PEG ratio, for for price-to-earnings growth. Using Amazon.com a (NASDAQ: AMZN  ) s an example, Anand walks us through the PEG ratio, as well as other indicators of company growth, in the following video.

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Anand Chokkavelu has no positions in the stocks mentioned above. The Motley Fool owns shares of Amazon.com, Intuitive Surgical, and Coca-Cola and has options on salesforce.com. Motley Fool newsletter services recommend Amazon.com, Intuitive Surgical, salesforce.com, Coca-Cola, and Procter & Gamble. Try any of our Foolish newsletter services free for 30 days. We Fools don't all hold the same opinions, but we all believe that considering a diverse range of insights makes us better investors. The Motley Fool has a disclosure policy.


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