PEG Ratio = P/E Ratio ÷ Expected Annual EPS Growth Rate (%)
The Short Version
The PEG ratio refines the P/E ratio by factoring in expected earnings growth, making it easier to compare companies growing at different speeds. A high-growth company can 'deserve' a higher P/E than a slow-growth one — PEG tries to normalize for that.
Explain It Like I'm 10
Imagine two lemonade stands. Stand A costs $200 to buy and made $20 profit last year (P/E of 10), but it's not growing at all. Stand B costs $400 and made $20 profit too (P/E of 20 — seems way pricier!), but it's growing its profit by 20% every year. The PEG ratio adjusts for that growth difference, so a 'more expensive-looking' stand that's actually growing fast might turn out to be the better deal once you account for where it's headed, not just where it is today.
Step-by-Step Example
- 1 Stock's P/E ratio: 30.
- 2 Analysts expect its earnings to grow 15% per year.
- 3 Divide: PEG = 30 ÷ 15 = 2.0.
- 4 A PEG around 1.0 is traditionally seen as 'fair value' relative to growth; 2.0 suggests the stock may be pricey even after accounting for its growth.
- 5 Compare to another stock: P/E of 15, expected growth of 15% → PEG = 15 ÷ 15 = 1.0 — by this measure, this second stock looks like the more reasonably priced option relative to its own growth.
A stock with a P/E of 30 and expected earnings growth of 15% per year has a PEG of 2.0.
Quick Recap
- ✓ A PEG around 1.0 is traditionally viewed as 'fairly valued' relative to growth; below 1.0 may suggest undervaluation.
- ✓ PEG is only as reliable as the growth estimate feeding it — overly optimistic projections distort the result.