How to interpret the PEG ratio: growth at a reasonable price

The PEG ratio (Price/Earnings to Growth) corrects a classic limitation of the P/E: a company with a high P/E can be cheap if it grows very fast, and one with a low P/E can be expensive if it does not grow. The PEG puts both things on the same scale.

The formula

The PEG divides the P/E by the expected earnings growth rate (as a percentage). For example, a company with a P/E of 30 growing at 30% a year has a PEG of 1.0. Another with a P/E of 15 growing at 5% has a PEG of 3.0: in growth terms, the second is more expensive despite its lower P/E.

How to read the result

• PEG near 1.0: the price is reasonably aligned with growth.
• PEG below 1.0: a possible opportunity — you pay little for the expected growth.
• PEG above 2.0: the market is pricing in a lot of growth; the margin for error narrows.

Mind its limits

The PEG depends entirely on the growth estimate, which is uncertain by nature. If analysts project overly optimistic growth, the PEG will look attractive when it is not. It pays to check where that growth comes from (is it sustainable? from more sales or from buybacks?) and to combine it with other quality and financial-health metrics.

The PEG also works poorly for cyclical companies or those without stable earnings, where growth jumps from year to year. It is an excellent tool for businesses with predictable growth, not a universal truth.