PEG Ratio (Price/Earnings to Growth) — What Is It?
The PEG ratio combines P/E with earnings growth rate. Learn how to use PEG to evaluate whether growth company stocks are expensive or cheap.
What is the PEG Ratio?
PEG (Price/Earnings to Growth) is a valuation metric that extends the classic P/E by earnings growth rate. It answers the question: "Is a high P/E justified by fast earnings growth?"
Formula: PEG = (P/E) / (annual earnings growth in %)
Why is PEG Better than P/E?
The P/E ratio alone doesn't tell if a company is expensive:
- Company A: P/E = 30, earnings growth 30% annually → PEG = 1.0
- Company B: P/E = 15, earnings growth 5% annually → PEG = 3.0
Company A is cheaper relative to growth rate, despite higher P/E. Peter Lynch (legendary Magellan Fund manager) popularized PEG and believed that PEG = 1.0 means "fairly valued" company.
PEG Interpretation
| PEG | Interpretation |
|---|---|
| < 1.0 | Potentially undervalued — earnings growth exceeds valuation |
| 1.0 | Fairly valued — P/E matches growth rate |
| 1.0-2.0 | Expensive or trading at quality premium |
| > 2.0 | Probably overvalued |
Practical Example
Company XYZ:
- Stock price: 200 PLN
- Earnings per share (EPS): 10 PLN
- P/E = 200 / 10 = 20
- Projected EPS growth: 25% annually
- PEG = 20 / 25 = 0.8 → potentially attractive
Same company, but EPS growth = 10%:
- PEG = 20 / 10 = 2.0 → expensive
PEG Limitations
- Growth forecast is uncertain — PEG relies on future earnings, which may not materialize
- Doesn't work for companies without earnings — startups with negative EPS have negative PEG (meaningless)
- Doesn't account for risk — two companies with PEG = 1.0 can have completely different risk profiles
- Doesn't account for dividends — company paying 5% dividend has additional value invisible in PEG
- Depends on data source — trailing PEG (historical data) vs forward PEG (forecasts)
PEG vs Other Metrics
Use PEG together with other metrics:
- P/B — does the company have solid assets?
- Margin of safety — does the price provide safety buffer?
- Debt/Equity — is growth financed by excessive debt?
- Free Cash Flow — do earnings translate to cash?
How Freenance Can Help
Freenance helps track portfolios of growth and dividend stocks in one place. The dashboard shows individual position values, making it easier to make decisions about overweighting or reducing based on ratio analysis.
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