How are you supposed to know when an ASX growth share is trading at good value?
Finding businesses with single digit price/earnings ratios, or at least low double-digit ones, are accepted as being cheap if those businesses are growing.
But how can you tell if shares like a2 Milk Company Ltd (ASX: A2M) or Costa Group Holdings Ltd (ASX: CGC) are trading at good value?
Firstly, I only want to buy shares that appear to have long growth runways. There's no point buying a share at a high price if it only has one good year of growth in it.
Businesses that are projected to grow year on year for multiple years can surprise the market on the upside in one year or make an acquisition to go up even faster.
One of the best ways to consider growth shares is the PEG ratio. A p/e ratio may tell you how expensive it is to last year's earnings, but it doesn't take into account the growth rate of that business.
The PEG ratio tries to adjust for growth. If a business has a p/e ratio of 20 and it grows profit by 20% then it has a PEG of 1. If that same business has a p/e ratio of 20 but grows profit by 40% then its PEG ratio is 0.5 – this is very good on the PEG scale.
If something has a p/e ratio of 20 but grows profit at 10% then it has a PEG of 2.
All things being equal, the lower the PEG the higher your returns are likely to be as long as the market recognises it had priced the share wrongly before.
Foolish takeaway
It's quite hard to find ASX shares with PEG ratios of below 1 at the moment due to high(ish) valuations and slowing growth for many businesses.
