Chegg shares fell by -15.1% during the day's afternoon session, and are now trading at a price of $20.74. Is it time to buy the dip? To better answer that question, it's essential to check if the market is valuing the company's shares fairly.
Chegg, Inc. operates direct-to-student learning platform that supports students starting with their academic journey and extending into their careers with products and services to support and help them better understand their academic course materials. The company belongs to the Consumer Defensive sector, which has an average price to earnings (P/E) ratio of 24.21 and an average price to book (P/B) ratio of 4.09. In contrast, Chegg has a trailing 12 month P/E ratio of 14.8 and a P/B ratio of 2.5.
P/B ratios are calculated by dividing the company's market value by the book value of its equity. Equity refers to all of the company's assets minus its liabilities. Traditionally, a P/B ratio of around 1 shows that a company is fairly valued, but owing to consistently higher valuations in the modern era, investors generally compare against sector averages.
P/E ratios have their limits on their usefulness too. Since the P/E ratio is the share price divided by earnings per share, the ratio is determined partially by market sentiment on the stock. Sometimes a negative sentiment translates to a lower market price and therefore a lower P/E ratio -- and there might be good reasons for this negative sentiment.
One of the main reasons not to blindly invest in a company with a low P/E ratio is that it might have low growth expectations. Low growth correlates with low stock performance, so it's useful to factor growth into the valuation process. One of the easiest ways to do this is to divide the company's P/E ratio by its expected growth rate, which results in the price to earnings growth, or PEG ratio.
When we do this for Chegg, we obtain a PEG ratio of 0.87, which indicates that the market is undervaluing the company's projected growth (a PEG ratio of 1 indicates a fairly valued company). Your analysis of the stock shouldn't end here. Rather, a good PEG ratio should alert you that it may be worthwhile to take a closer look at the stock.