The PEG Ratio: Re-Reading Value with Growth Included
On PER alone, growth stocks always look expensive, because future earnings are priced in early. PEG corrects for this: divide PER by the annual earnings growth rate to re-measure the price with growth speed included.
One division
The formula is PEG = PER ÷ annual earnings growth (%). A stock at PER 30 growing profits 30% a year scores 30 ÷ 30 = 1.0. A stock at PER 10 growing 5% scores 2.0. The first looks three times more expensive on PER, yet with growth included it is the cheaper one.
Common reading: below 1.0 is cheap relative to growth, above 2.0 is expensive even after growth. Peter Lynch popularized the yardstick, and it remains one of the most used checks for growth names.
Where the growth number comes from
The denominator rarely appears on quote screens, so you compute it. The simplest source is the filings: take the last two or three years of operating or net profit and estimate the annual growth rate. Using analyst forecasts instead gives a forward PEG.
Either works, but keep the basis consistent. A PEG from past growth and one from forecasts can differ widely. When comparing several stocks, use growth rates computed the same way or the ranking means nothing.
The traps
First, growth is fragile arithmetic: three years of 30% growth is no promise of the next three. When growth breaks, PEG deteriorates instantly. Second, one-off gains inflate the growth rate and flatter the PEG; strip out items like asset sales.
Third, near-zero growth makes the denominator tiny and the PEG meaninglessly large. For those stocks, the Graham number or dividend yardsticks fit better. Each formula suits a different type of stock, which is the point of this series.
Frequently asked questions
- Is PEG below 1.0 a buy?
- No. It only says the price is low relative to growth speed. Whether the growth can continue, the quality of the earnings, and the direction of money flow still need checking.
- What about a company that just turned profitable?
- The first year after a turnaround shows growth in the hundreds of percent and distorts PEG. Wait until two or three years of profit history accumulate.
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