Why you should calculate your own P/E and PEG ratios — and the right way to do it

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Here's our Club Mailbag email investingclubmailbag@cnbc.com — so you send your questions directly to Jim Cramer and his team of analysts. We can't offer personal investing advice. We will only consider more general questions about the investment process or stocks in the portfolio or related industries. This week's questions: I read your article about price/earnings-to-growth (PEG) ratios and found it very helpful, particularly on when to use them and how they fit into the whole investing scheme. Where and how can I find a stock's reliable compound annual growth rate (CAGR)? Aren't most CAGRs an opinion? And, if so, how do I know I can rely on the projection selected? Thank you in advance. — Bill Reed I notice that P/E ratios can be quite inconsistent and vary from site to site. PEG can also be very difficult to find and is not on the CNBC site. Can you recommend the most reliable place to find these metrics please? Kind regards. — Mike M We are grouping these two questions together because they are closely related. Most data sources are accurate, but there can be inconsistencies. Often the information is correct, but it's not the data you need. For example, we often see price-to-earnings multiples that are calculated using the trailing 12-month results, when we (and Wall Street) are looking for estimates for the coming 12 months. After all, stock prices are based on expectations, not past results. The P/E may also not be updated using the most recent price, which could make a big difference to the valuation if there was a big swing. So it's always best to calculate the ratio yourself. For the forward P/E, divide the current share price by the earnings estimate for the coming fiscal year. Earnings estimates are the most watched metric on Wall Street, so you can be confident in the data found on CNBC.com. Type in the ticker, and select the earnings tab (see table below for Nvidia ). Before we figure out a stock's PEG ratio, we need to calculate its compound annual growth rate or CAGR. Let's assume we want to calculate a 5-year CAGR. We need to acknowledge that growth rates slow as a company matures, but five years will provide a good idea of a relatively long-term growth rate. Anything beyond five years is going to be incredibly hard to predict. Even a 5-year estimate should be taken with a grain of salt. After all, investors who calculated a 5-year CAGR in 2017 likely weren't factoring in a global pandemic. The equation to calculate a CAGR for X number of years is as follows: [(Future EPS estimate/Current EPS)^(1/x)]-1 Let's consider Nvidia using the data above. The chipmaker generated $12.96 per share in year 0 (the 2023 year ended Jan. 28, 2024) and is expected to generate $44.89 per share at the end of 2028 (year 5). We can calculate the 5-year CAGR as follows: [(44.89/12.96) ^(1/5)=28.21% 1. Divide 44.89 (future EPS estimate for year 5) by 12.96 (EPS in 2023). This equals 3.46. 2. Divide 1/5 (5 being the number of years). This equals 0.2. 3. Raise 3.46 (total from Step 1) to the power of 0.2 (from Step 2). This equals 1.2821. 4. Subtract 1 from the 1.2821 (result of Step 3). This equals .2821, or 28.21%. We can then check our work by taking the first-year estimate and multiplying it by (1+result)^X. In this case, 12.96*(1.2821^5) does indeed equal $44.89. Once we have a CAGR as a proxy for long-term growth, we can take the figure (not as a percent) and use it in our PEG calculation. Nvidia is trading at 41 times earnings, our equation would be 41/28.21 which equals a PEG ratio of 1.45 times. As a general rule, a PEG ratio of 1 or lower indicates you're getting future growth at a good value. On the high side, a PEG of 2 or above suggests you may be paying more for future growth than you should be. Nvidia is right in the middle. However, the stock has just gone on a monster run and estimates have proven far too conservative over the past year. Most importantly, the PEG isn't the end-all-be-all, It's just another way of thinking about valuation. Just because the PEG isn't below 1, doesn't mean we can ignore that Nvidia. The chipmaker is leading the AI mega-trend that will impact every company across all industries over the next decade. (See here for a full list of the stocks in Jim Cramer's Charitable Trust.) As a subscriber to the CNBC Investing Club with Jim Cramer, you will receive a trade alert before Jim makes a trade. Jim waits 45 minutes after sending a trade alert before buying or selling a stock in his charitable trust's portfolio. If Jim has talked about a stock on CNBC TV, he waits 72 hours after issuing the trade alert before executing the trade. THE ABOVE INVESTING CLUB INFORMATION IS SUBJECT TO OUR TERMS AND CONDITIONS AND PRIVACY POLICY , TOGETHER WITH OUR DISCLAIMER . NO FIDUCIARY OBLIGATION OR DUTY EXISTS, OR IS CREATED, BY VIRTUE OF YOUR RECEIPT OF ANY INFORMATION PROVIDED IN CONNECTION WITH THE INVESTING CLUB. NO SPECIFIC OUTCOME OR PROFIT IS GUARANTEED. Traders work on the floor of the New York Stock Exchange during morning trading on May 24, 2024. Michael M. Santiago | Getty Images