My understanding is that the growth factor in PEG is Growth in Earnings, or sustainable growth, not Growth in Dividends. Am I correct in this? QBank seems to say otherwise: Consider the statement: “Unlike many valuation metrics that incorporate dividend discounting, the PEG ratio may be used to value firms with zero expected dividend growth prospects.” Is this statement correct? A) No, because the PEG ratio is undefined for zero-growth companies. B) Yes, because the expected dividend growth rate is cancelled out in the computation of the PEG ratio. C) Yes, because the computation of the PEG ratio does not use the rate of expected dividend growth. Your answer: C was incorrect. The correct answer was A) No, because the PEG ratio is undefined for zero-growth companies. The PEG ratio measures the tradeoff between P/E and expected dividend growth (g). The formula for the PEG ratio is: PEG = (P/E) / g. Firms with zero expected dividend growth will have an infinite (or undefined) PEG ratio due to division by zero.
Earnings and dividends grow at the same rate, denoted by g.
> Firms with zero expected dividend growth will have an infinite (or undefined) PEG ratio due to division by zero. The idea is that dividends will have to have greater than zero growth rate sooner or later, even if it takes a hundred years, but if it is already known that the growth is zero, then PEG is undefined. The only troble here is that over say the next 5 years (which is what’s typically done in projecting g), it is possible to have constant dividends while earnings are growing at (say) 10% annually. In that case, analysts would use 10% in the denominator, perfectly fine. Conclusion: bad question from Qbank, IMHO.