A high P/E ratio doesn't always mean a stock is expensive, and a low one doesn't always mean it's cheap. Fast-growing companies deserve higher P/Es than slow-growing ones. The price/earnings-to-growth (PEG) ratio adjusts for this.
The formula
PEG = P/E ratio ÷ annual earnings growth rate (as a whole number)
Example: Company A trades at a P/E of 30 and is expected to grow earnings 30% a year, so its PEG is 1.0. Company B trades at a P/E of 15 but is expected to grow just 5% a year, so its PEG is 3.0. Despite the lower P/E, Company B is the more expensive stock relative to its growth.
What's a good PEG?
The PEG ratio was popularized by investor Peter Lynch, who suggested that a fairly valued company has a P/E roughly equal to its growth rate, a PEG of about 1.
- Below 1: potentially undervalued relative to expected growth.
- Around 1: roughly fairly valued.
- Above 2: investors are paying a lot for each unit of growth.
Treat these as starting points for research, not buy or sell signals.
Limitations
- It depends on a forecast. Most PEGs use analysts' estimates of future growth, which are often wrong. Check which growth figure and period is being used.
- It ignores risk and quality. A PEG of 1 for a stable, cash-rich company is very different from a PEG of 1 for a heavily indebted one.
- It breaks down at the extremes. For companies with no earnings, shrinking earnings or very slow growth, the PEG is meaningless or misleading.
- It ignores dividends. Mature companies that return a lot of cash can look expensive on PEG. Some investors add the dividend yield to the growth rate to correct for this.
Using PEG with other tools
PEG is most useful for comparing growth companies within the same industry. Pair it with free cash flow, margins and the balance sheet. Read growth vs. value investing for how valuation fits into each style, and estimate intrinsic value directly with the DCF calculator. The Valuation pillar in AI Insights considers growth-adjusted valuation for every stock.
This article is educational and not investment advice.
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