What is the PEG Ratio?
The PEG (Price/Earnings to Growth) ratio refines the P/E ratio by factoring in the company's expected earnings growth rate. It helps investors assess whether a stock's price is justified relative to its growth prospects.
Formula:
PEG = (P/E Ratio) ÷ (Expected Annual EPS Growth Rate in %)
- The P/E is usually the forward P/E (based on estimated future earnings).
- The growth rate is typically the expected annual EPS growth over the next 3–5 years (expressed as a percentage, e.g., 15% growth = 15).
Peter Lynch popularized the PEG in the 1980s–1990s, suggesting a PEG of 1.0 or lower indicates fair value or undervaluation: you're paying $1 in P/E for each 1% of expected growth.
General Interpretation
| PEG Range | Interpretation |
|---|---|
| PEG ≈ 1 | Fairly valued — growth justifies the price |
| PEG < 1 | Potentially undervalued — growth is "cheap" relative to price |
| PEG > 1 | Potentially overvalued — paying a premium for growth |
| PEG > 2 | Often considered expensive unless extraordinary growth is certain |
| Negative/undefined | Negative earnings or growth — ratio becomes meaningless |
Hypothetical Examples
Using forward P/E and 5-year expected EPS growth rate:
| Scenario | Forward P/E | Expected Growth | PEG | Interpretation |
|---|---|---|---|---|
| Fair value (mature growth stock) | 20 | 20% | 1.0 | Fairly priced: investors pay exactly in line with growth expectations |
| Undervalued (accelerating growth) | 18 | 30% | 0.6 | Attractive: strong growth at a discount — potential bargain |
| Overvalued (high expectations) | 40 | 15% | 2.67 | Expensive: market prices in growth that's not exceptional |
| Very cheap growth (value + growth) | 12 | 25% | 0.48 | Strongly undervalued: classic "growth at a reasonable price" (GARP) |
| Premium growth (high-flyer tech) | 50 | 40% | 1.25 | Slightly expensive but justifiable if growth materializes |
Real-World Considerations
In practice, PEG is most useful for growth stocks where high P/E might be justified by rapid earnings expansion.
| Company Type | Forward P/E | Growth | PEG | Analysis |
|---|---|---|---|---|
| High-growth AI firm | 45 | 40% | 1.13 | High P/E looks expensive in isolation, but PEG shows premium is mostly explained by growth |
| Consumer staples giant | 18 | 8% | 2.25 | Looks overvalued — investors paying a lot for modest growth |
| Cyclical turnaround | 10 | 20% | 0.5 | Appears deeply undervalued if growth forecasts prove accurate |
Market Benchmarks (Early 2026)
Actual PEG values fluctuate with market conditions and analyst estimates:
| Sector | Typical PEG Range | Notes |
|---|---|---|
| High-growth tech (Nvidia, Tesla) | 1.2–2.0+ | Premium multiples when sentiment is strong |
| Stable blue-chips (P&G, Coca-Cola) | 2.0+ | Slower growth commands lower expectations |
| Value sectors (energy, financials) | < 0.8 | During recoveries, growth often underpriced |
When PEG Works Well (Telling a Story)
| Condition | Why It Works |
|---|---|
| Same-industry comparisons | Apples-to-apples growth expectations |
| GARP screening | Finding growth at a reasonable price |
| Reliable growth estimates | Mature companies with consistent histories |
| Stable economic conditions | Forecasts more likely to hold |
When PEG Can Mislead (Lying)
| Situation | Why PEG Fails |
|---|---|
| Overly optimistic forecasts | Analyst growth estimates often too bullish, especially for hot stocks |
| Ignores risk factors | Debt, margins, competitive threats not captured |
| Low/no growth companies | Ratio becomes meaningless or distorted |
| Negative earnings | Can't calculate meaningful PEG |
| Cyclical businesses | Short-term growth spikes distort long-term picture |
| Economic cycles | Forecasts made in boom may not hold in recession |
Summary
The PEG ratio adds crucial context to P/E by asking: "Am I paying too much for the growth I'm getting?"
It's a favorite of growth-oriented value investors (like Peter Lynch's style). A stock with a P/E of 50 might look expensive — until you see it's growing at 50% annually (PEG = 1.0). A stock with a P/E of 15 might look cheap — until you see growth is only 5% (PEG = 3.0).
Use PEG alongside other metrics — ROE, debt, free cash flow — rather than in isolation for better decisions.
Peter Lynch's rule of thumb still holds: PEG under 1.0 with reliable growth estimates is where value investors find opportunity.