What Is the PEG Ratio?
The PEG ratio adjusts the P/E ratio for growth by dividing it by the company's expected earnings growth rate, expressed as a whole number. The formula is PEG = P/E / Expected Annual EPS Growth Rate, so a company trading at 30x earnings and growing 30% per year has a PEG of 1.0x.
The intuition is that a raw P/E comparison unfairly penalizes fast growers: a 30x multiple can be cheaper than a 12x multiple if earnings are compounding far faster. PEG puts companies with different growth profiles on a more comparable footing.
How It Works
Analysts typically use a forward P/E and a consensus estimate of EPS growth over the next three to five years. By convention, a PEG around 1.0x suggests the multiple is roughly in line with growth, below 1.0x hints the stock may be cheap for its growth, and well above 1.0x suggests investors are paying a premium beyond what growth alone explains.
These thresholds are rules of thumb, not laws: quality, margins, and interest rates all shift what a fair PEG looks like. The metric also breaks down for companies with negative, negligible, or highly volatile growth, since the denominator becomes meaningless.
Example
Company A trades at a 30.0x P/E with 25% expected EPS growth, so its PEG is 30 / 25 = 1.2x. Company B trades at a lower 15.0x P/E but is growing only 8% per year, giving a PEG of 15 / 8 = 1.9x.
Despite its higher headline multiple, Company A is actually cheaper on a growth-adjusted basis. In growth-equity and hedge fund interviews, PEG often comes up as a quick way to argue that an expensive-looking stock is reasonably priced.
Why It Matters
PEG is a fast screen for growth-at-a-reasonable-price investing and a useful check against overpaying for momentum. It forces the analyst to make growth expectations explicit rather than hiding them inside a bare multiple.
Its limits deserve respect: growth estimates are often wrong, the metric ignores risk and capital intensity, and it implicitly assumes a linear relationship between fair P/E and growth that does not hold at extremes. Serious valuation work uses PEG as a starting signal, then digs into a DCF or full comps analysis.
