One way to value a company is to compare a firm's earnings growth to its price/earnings ratio. (A stock's price/earnings ratio is found by taking a stock's price per share divided by trailing 12 months earnings per share. For example, a stock with a per-share price of $20 and trailing 12-month earnings of $2 per share would have a price/earnings ratio of 10. You can substitute trailing 12-month earnings with future 12-month earnings in the equation to give you a price/earnings ratio based on next year's earnings estimates).

The relationship between price/earnings ratio and earnings growth is captured by a stock's PEG (Price-to-Earnings Growth) ratio.

For example, let's say you are interested in buying stock in a company with 25% annual earnings growth and a Price/Earnings Ratio of 50. The PEG ratio in this case would be the P/E ratio (50) divided by the annual earnings growth rate (25) or 2.

Now what if a company has an earnings growth rate of 20% but a price/earnings ratio of 10? The PEG ratio in this instance would be 0.5 (10 divided by 20).

Using PEG ratios as a way to compare stocks can be eye opening. Indeed, I wonder how some people justify buying those seemingly high-priced technology? In some cases, those high valuations may not seem so high when you look at PEG ratios.

For example, most investors would think that Oracle, with its price/earnings ratio of around 90, is a lot more expensive than Coca-Cola. However, when you compare PEG ratios, Coca-Cola (PEG of 3.5) is significantly pricier than Oracle (PEG of 1.77). That's because Oracle's earnings growth rate for the current fiscal year is roughly five times greater than Coca-Cola's earnings-growth rate.

Of course, evaluating stocks based on PEG ratios is not an infallible tool. Nevertheless, using PEG ratios may provide additional information that can be used to choose between two stocks.