PEG Ratio
Quick Definition
Price/Earnings-to-Growth ratio adjusts P/E by earnings growth rate, helping identify undervalued growth stocks.
What Is PEG Ratio?
The PEG (Price/Earnings-to-Growth) ratio improves upon the P/E ratio by factoring in a company's expected earnings growth rate. It helps investors find potentially undervalued growth stocks.
Formula: PEG = P/E Ratio / Annual EPS Growth Rate
Interpretation:
- PEG < 1: Potentially undervalued (price doesn't reflect growth)
- PEG = 1: Fairly valued (price matches growth expectations)
- PEG > 1: Potentially overvalued (price exceeds growth potential)
Example:
- Company A: P/E of 30, growth rate of 30% → PEG = 1.0
- Company B: P/E of 20, growth rate of 10% → PEG = 2.0
- Despite lower P/E, Company B is "more expensive" relative to its growth
Limitations:
- Relies on earnings estimates (which can be wrong)
- Doesn't account for risk differences
- Less useful for mature, slow-growth companies
- Growth rates can be calculated differently
Best Use Cases:
- Comparing growth stocks
- Evaluating tech and high-growth sectors
- Screening for value in growth categories
Formula
Formula
PEG = P/E Ratio / EPS Growth Rate (%)PEG Ratio Example
- 1P/E of 25 with 25% growth = PEG of 1.0 (fair value)
- 2P/E of 15 with 30% growth = PEG of 0.5 (potentially undervalued)
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Related Terms
Price-to-Earnings Ratio (P/E)
A valuation metric comparing a company's stock price to its earnings per share, indicating how much investors pay per dollar of earnings.
Revenue
The total amount of money a company earns from its business activities before any expenses are deducted, also called sales or top line.
EBITDA (Earnings Before Interest, Taxes, Depreciation & Amortization)
A widely used profitability metric that strips out financing, tax, and non-cash capital costs to approximate operating cash generation.
Net Income
A company's total profit after all expenses, taxes, and costs have been deducted from revenue—the "bottom line" of the income statement.
Balance Sheet
A financial statement showing a company's assets, liabilities, and shareholders' equity at a specific point in time, following the equation Assets = Liabilities + Equity.
Free Cash Flow (FCF)
The cash a company generates from operations after accounting for capital expenditures, representing money available for dividends, debt repayment, or reinvestment.
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