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In Peter Lynch's One Up on Wall Street, he gave a simple, straight-forward explanation as to his preferred metric for doing a quick and dirty valuation of a firm's investment prospect:

A slightly more complicated formula enables us to compare growth rates to earnings, while also taking the dividends into account. Find the long-term growth rate (say, Company X's is 12 percent), add the dividend yield (Company X pays 3 percent), and divide by the p/e ratio (Company X's is 10). 12 plus 3 divided by 10 is 1.5.

Less than a 1 is poor, and a 1.5 is okay, but what you're really looking for is a 2 or better. A company with a 15 percent growth rate, a 3 percent dividend, and a p/e of 6 would have a fabulous 3.

However, I'm not sure he gave the name for it. I got the book out of the library and only copied down the quote. Is this the Dividend Adjusted PEG Ratio he's talking about?

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Essentially, yes, Peter Lynch is talking about the PEG Ratio.

The Price/Earnings to Growth (PEG) Ratio is where you take the p/e ratio and then divide that by the growth rate (which should include any dividends). A lower number indicates that the stock is undervalued, and could be a good buy.

Lynch's metric is the inverse of that: Growth rate divided by the p/e ratio. It is the same idea, but in this case, a higher number indicates a good value for buying.

In either case, the idea behind this ratio is that a fairly priced stock will have the p/e ratio equal the growth rate. When your growth rate is larger than your p/e ratio, you are theoretically looking at an undervalued stock.

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