PEG – Price/Earnings to Growth Ratio
PEG ratio combines valuation (P/E) with expected earnings growth. It helps answer whether a high P/E is justified by rapid growth.
How PEG is Calculated
Basic formula:
- P/E is the price-to-earnings ratio
- EPS Growth is the expected annual earnings per share growth (in percent, without the % sign)
Example: A company has P/E of 30 and expected earnings growth of 15% annually. PEG = 30 / 15 = 2.0.
How to Interpret the Result
| PEG | Interpretation |
|---|---|
| < 1.0 | Potentially undervalued relative to growth |
| 1.0 | "Fair" valuation (P/E = growth) |
| 1.0–2.0 | Slightly overvalued |
| > 2.0 | Potentially expensive |
Rule of thumb: PEG = 1 means P/E equals the growth rate. A company with 20% growth and P/E of 20 has PEG of 1.
What PEG Reveals
PEG helps compare companies with different growth rates:
| Company | P/E | Growth | PEG | Assessment |
|---|---|---|---|---|
| A | 15 | 5% | 3.0 | Expensive for slow growth |
| B | 30 | 25% | 1.2 | Reasonable for fast growth |
| C | 20 | 30% | 0.7 | Cheap relative to growth |
Company B with high P/E is actually cheaper than Company A with low P/E.
Which Growth Rate to Use
There are different approaches:
| Variant | Source | Pros/Cons |
|---|---|---|
| Forward PEG | Analyst estimate for 1 year | Current, but may be inaccurate |
| 5-year PEG | Average expected growth for 5 years | Longer-term view |
| Historical PEG | Actual growth over 3–5 years | Verified, but past |
Most commonly, 5-year expected EPS growth is used.
Limitations of PEG Ratio
PEG has important limits:
- Depends on estimates – expected growth may be inaccurate
- Linear assumption – assumes constant growth
- Negative growth – PEG doesn't make sense for declining companies
- Low growth – PEG is always high for slow companies
- Ignores quality – doesn't distinguish sustainable vs. one-time growth
PEG vs. P/E
| Situation | P/E | PEG | Conclusion |
|---|---|---|---|
| Fast-growing company | High | Low | P/E is justified |
| Slow company | Low | High | "Cheap" company is actually expensive |
| Quality growth | Medium | Low | Good opportunity |
Industry Usage
PEG is most useful for:
- Growth stocks – technology, biotechnology
- Comparison within industry – which growth company is cheaper
- Growth vs. Value – quantifying the growth premium
For value stocks with low growth, PEG is less relevant.
Peter Lynch and PEG
PEG was popularized by legendary investor Peter Lynch:
"A fairly priced company will have its P/E equal to its earnings growth rate."
Lynch preferred PEG below 1.0 as a signal of undervaluation.
How to Use the Indicator in Practice
For comprehensive valuation, combine PEG with:
- P/E – basic valuation
- P/FCF – earnings quality
- ROIC – growth sustainability
- Net Profit Margin – profitability
Verify:
- Is growth sustainable? (Look at history)
- What is the source of growth? (Organic vs. acquisitions)
- Are analyst estimates realistic?
Practical Tip
PEG below 1.0 is attractive, but verify growth quality. A company may have low PEG due to one-time growth (division sale, accounting adjustments) or unrealistic estimates. A quality company with PEG of 1.5 and sustainable growth may be a better investment than a company with PEG of 0.8 and uncertain growth.