Price/Earnings-to-Growth (PEG) Ratio

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Price/Earnings-to-Growth (PEG) Ratio

The PEG ratio adjusts the price-to-earnings (P/E) ratio for expected earnings growth, giving a fuller view of a stock’s valuation by factoring in its growth prospects.

Definition

PEG = (Price / Earnings per Share) ÷ Earnings Growth Rate

Commonly, the growth rate is expressed as a percentage (e.g., 20). In that case PEG = (P/E) ÷ (Growth %). If you use a decimal growth rate (e.g., 0.20), convert consistently: PEG = (P/E) ÷ (Growth rate as decimal) or equivalently (P/E) × (1 / growth decimal). Always check which convention a data source uses.

How to calculate

  1. Calculate the P/E ratio: Price per share ÷ EPS.
  2. Obtain an earnings growth rate (analyst estimate or historical). Decide whether to use one-year, three-year, or five-year growth.
  3. Divide the P/E by the growth rate (using the same units as your growth number).

Example:
– Company A: Price = $46; EPS = $2.09 → P/E = 46 / 2.09 = 22.0
Earnings growth = (2.09 / 1.74) − 1 = 20% → PEG = 22 ÷ 20 = 1.1
– Company B: Price = $80; EPS = $2.67 → P/E = 80 / 2.67 = 30.0
Earnings growth = (2.67 / 1.78) − 1 = 50% → PEG = 30 ÷ 50 = 0.6

In this example, Company B, despite a higher P/E, has a lower PEG and may represent better value relative to its growth.

Interpretation

  • PEG ≈ 1.0: stock is roughly fairly valued relative to expected growth.
  • PEG < 1.0: often interpreted as undervalued (attractive), since the stock price is low relative to growth expectations.
  • PEG > 1.0: may be overvalued relative to growth.
  • Negative PEG: results from negative earnings or negative growth estimates and signals caution—interpretation depends on context.

Variants and terminology

  • Forward PEG: uses expected future earnings and growth (analyst forecasts).
  • Trailing PEG: uses historic earnings and growth rates.
    Be sure to know which is reported; different sources use different inputs.

Strengths

  • Adds growth context to the P/E ratio, helping to compare companies with different growth profiles.
  • Simple and widely used for a quick, relative valuation check.

Limitations

  • Sensitive to the growth-rate input: different forecast horizons or analysts produce different PEGs.
  • Relies on earnings estimates, which can be inaccurate or overly optimistic.
  • Not meaningful for firms with negative earnings or highly volatile earnings.
  • Industry norms vary—what’s a “good” PEG in one sector may not apply in another.
  • Ignores balance-sheet strength, cash flow quality, and differences in business models.

Practical guidance

  • Use PEG as one tool among many (P/E, P/B, free cash flow, ROE, qualitative factors).
  • Compare PEGs within the same industry and check the source and horizon of the growth estimate.
  • Treat PEG < 1.0 as a signal to investigate further, not an automatic buy signal.

Bottom line

The PEG ratio refines the P/E by accounting for expected earnings growth, offering a quicker, growth-adjusted valuation metric. Its usefulness depends on the quality and consistency of the growth assumptions—use it alongside other financial measures and industry context.