PEG Ratio (Price/Earnings Growth)
The P/E ratio divided by earnings growth rate. Compares valuation to growth, helping determine if a stock is cheap or expensive relative to its growth prospects.
The PEG Ratio (Price/Earnings-to-Growth) divides the P/E ratio by the expected earnings growth rate. It adjusts valuation for growth, helping investors identify whether a stock is cheap or expensive relative to its growth prospects.
Formula
PEG Ratio = P/E Ratio ÷ Earnings Growth Rate (%)
For example, if P/E is 40 and earnings are expected to grow 20% annually, PEG = 40 ÷ 20 = 2.0
Example
Nvidia (NVDA) might have a P/E of 60 and expected earnings growth of 30% annually, for a PEG of 2.0. Tesla (TSLA) might have P/E of 50 but faster growth of 40%, for a PEG of 1.25, suggesting it's "cheaper" relative to its growth.
How to Interpret It
- PEG < 1.0: The stock is cheap relative to its growth rate. Potentially undervalued.
- PEG = 1.0: The stock is fairly valued; you're paying one dollar for one dollar of growth.
- PEG > 1.0: The stock is expensive relative to its growth rate. You're paying a premium.
- PEG > 2.0: Significantly overvalued, unless growth accelerates.
- Comparing growth rates: Use consensus analyst estimates or 5-year historical growth rates; don't rely on management guidance alone.
Limitations
- PEG relies on growth estimates, which are uncertain and often wrong, especially for fast-growing companies.
- Very high-growth companies (50%+ annual growth) might have PEG ratios below 1.0 yet still be expensive in absolute terms.
- PEG doesn't account for profitability timing; a company growing earnings but currently unprofitable won't have a meaningful PEG.
- The formula works best for mature, predictable growth; it's less useful for cyclic or highly variable growth.
Related Terms
- P/E Ratio — the foundation of the PEG calculation
- Earnings Growth — rate at which earnings are expected to increase
- Earnings Per Share — profit divided by share count
- Valuation — whether a stock is cheap or expensive