PEG Ratio

1.0 The Formula

Basic Form

formulaPEG = (Price / Earnings per Share) ÷ Annual EPS Growth Rate

     = P/E Ratio ÷ EPS Growth %

Both sides of the equation use earnings per share (EPS). The P/E ratio tells you how many dollars investors pay per dollar of current earnings. The growth rate tells you how fast those earnings are expanding. PEG divides one by the other.

Worked Example

Company A has the highest P/E (30) but is fairly valued because earnings growth matches. Company B looks cheaper on P/E (20) but is actually the most expensive on a growth-adjusted basis. Company C is the cheapest — the market is underpricing its growth.

2.0 Interpretation

The Benchmark Scale

What PEG = 1.0 Actually Means

A PEG of 1.0 implies the market expects the earnings growth rate to justify the current price. If a stock trades at 25x earnings with a 25% growth rate, the market is saying: "We'll pay 25 dollars per dollar of earnings because we believe earnings will be 25% higher next year." Whether that belief is correct is a different question.

Real-World Ranges

referencePEG < 0.5  │ Rare. Usually signals the market sees risk the
           │ numbers don't show (debt, regulation, cyclical peak).
           │
PEG 0.5–1.0│ Value territory. Common in out-of-favor sectors
           │ (energy, financials) or post-selloff tech names.
           │
PEG 1.0–1.5│ The sweet spot for GARP (Growth at a Reasonable
           │ Price) investors. Fair value with slight margin.
           │
PEG 1.5–2.5│ Growth premium. Typical for large-cap tech with
           │ strong moats (MSFT, GOOGL, AAPL).
           │
PEG > 3.0  │ Priced for perfection. Any earnings miss and the
           │ stock gets punished. High-conviction-only territory.

3.0 Growth Rate: Which One?

The PEG ratio is only as good as the growth number you plug in. This is where most mistakes happen.

Trailing vs. Forward

Calculating Growth Rate

formulaTrailing EPS Growth (YoY):

  growth_rate = ((EPS_current - EPS_prior) / |EPS_prior|) × 100

Example:
  EPS 2025: $6.20
  EPS 2024: $5.00

  growth_rate = ((6.20 - 5.00) / 5.00) × 100 = 24%

If current P/E = 30:
  PEG = 30 / 24 = 1.25

4.0 Edge Cases and Pitfalls

When PEG Breaks

• Negative earnings. If EPS is negative, the P/E is negative, and PEG is meaningless. Use price-to-sales or EV/revenue instead.
• Negative growth. If earnings are shrinking, dividing by a negative growth rate produces a negative PEG. Discard it — a negative PEG does not mean "undervalued."
• Zero growth. Division by zero. Mathematically undefined. A stock with zero growth has no business being evaluated on PEG.
• Cyclical earnings. Energy, mining, and commodity stocks have wildly fluctuating earnings. A PEG of 0.3 at the peak of a cycle does not mean undervalued — it means earnings are about to collapse.
• One-time charges. A massive write-down crushes EPS for one quarter, inflating the subsequent growth rate. The recovery "growth" isn't real growth — it's mean reversion.

Sector Comparisons

PEG is most useful when comparing stocks within the same sector. Cross-sector comparisons are misleading because baseline growth rates differ structurally:

5.0 PEG in Practice

Screening Filter

PEG works best as a first-pass filter. Screen a universe for PEG < 1.5, then do the real work: read the 10-K, check the balance sheet, understand the competitive position.

pseudocodeScreen:
  1. Filter: PEG < 1.5
  2. Filter: Market cap > $10B (liquidity)
  3. Filter: Positive FCF (business is real)
  4. Sort: PEG ascending

Result: A shortlist of growth stocks the market may be underpricing.
Then: Read the actual filings for each name on the list.

Pairing PEG with Other Metrics

PEG should never be used in isolation. Pair it with:

• P/E Ratio — the numerator of the PEG formula. Understand P/E first, then layer in growth adjustment.
• Free Cash Flow Yield — confirms the business generates actual cash, not just accounting earnings. A low PEG with negative FCF is a red flag.
• Debt-to-Equity — a low PEG fueled by leverage is not the same as organic growth. Check how the growth is being financed.
• Revenue Growth — EPS growth driven by buybacks (shrinking share count) is mechanically different from EPS growth driven by top-line expansion. Revenue growth confirms demand is real.
• Return on Equity (ROE) — high ROE + low PEG is the ideal combination. The business is efficient and priced below its growth rate.

The Peter Lynch Rule of Thumb

Lynch's original formulation was simple: a fairly valued company has a PEG of 1.0. He considered any stock with a PEG below 0.5 a strong buy and anything above 2.0 overpriced. He also added the dividend yield as a modifier:

formulaLynch Adjusted PEG = P/E ÷ (EPS Growth Rate + Dividend Yield)

Example:
  P/E: 18
  EPS Growth: 12%
  Dividend Yield: 3%

  Adjusted PEG = 18 / (12 + 3) = 1.20

This penalizes non-dividend payers and rewards companies returning cash to shareholders while still growing. It shifts the lens toward total return, not just earnings expansion.

6.0 Related Pages