Glossary
PEG ratio
The P/E ratio divided by the expected annual earnings growth rate, used to compare valuations across companies growing at different speeds.
The PEG ratio adjusts the price-to-earnings ratio for growth by dividing the P/E by the company's expected annual earnings growth rate. A plain P/E makes fast-growing companies look expensive almost by default; PEG asks whether that higher multiple is in line with how quickly profits are expected to rise.
How it works
The growth rate is entered as a whole number, so 15% growth is 15, not 0.15. Most data providers use analysts' consensus estimate of growth over the next three to five years, though some use one year or historical growth.
How it is read
The PEG ratio was popularized by fund manager Peter Lynch, and a common rule of thumb treats a PEG near 1 as fairly valued, below 1 as potentially cheap and well above 1 as rich. That benchmark is a convention, not a law; it ignores interest rates, risk and the quality of earnings.
Limits to keep in mind
- The growth input is a forecast. Change the five-year estimate from 30% to 20% and the software company's PEG jumps from 1.5 to 2.25. The ratio is only as good as the estimate.
- Low-growth and no-growth firms break it. Dividing by 1% or 2% produces huge PEGs, and negative growth makes the number meaningless.
- Dividends are left out. Mature companies that return cash through dividends look worse than they are; a variant adds dividend yield to the growth rate.
Investors who use PEG usually treat it as a screen to narrow a list, then check the growth assumptions behind each name.