PEG ratio
The PEG ratio divides a company’s P/E by its expected yearly profit growth, to show whether the price you pay is in line with how fast profit is growing.
PEG = P/E ratio ÷ Annual EPS growth rate (in %)
What it is
A high P/E is a bet that profit will grow fast. PEG checks that bet by putting the P/E next to the growth rate. A company on a P/E of 40 growing profit at 40% a year has a PEG of 1. A company on a P/E of 20 growing at 5% has a PEG of 4.
So PEG helps you compare a fast-growing company with a slow-growing one on a more even footing than P/E alone.
How to read it
A common rule of thumb says a PEG around 1 is fair, well below 1 may be cheap for the growth on offer, and well above 1 may be expensive. Treat this as a starting point, not a law.
Always ask where the growth number came from. Past growth is a fact. Future growth is a forecast. A PEG that looks cheap because of one boom year, or an analyst’s hopeful estimate, can be badly wrong.
Limits
PEG does not work for loss-making companies or companies with shrinking profit. It also ignores debt, cash flow and how reliable the growth is. A steady 15% grower may deserve a higher PEG than a company that grew 40% once and may never do it again.
For cyclical businesses, profit growth from a low base right after a bad year can make PEG look tiny. That is the cycle, not real growth.
Comparing two companies with PEG
Company A trades at ₹600 with EPS of ₹20, so P/E = 30. Its EPS has grown about 25% a year, so PEG = 30 ÷ 25 = 1.2. Company B trades at ₹180 with EPS of ₹12, so P/E = 15. Its EPS grows about 5% a year, so PEG = 15 ÷ 5 = 3. B has the lower P/E, but you pay more for each unit of its growth.
Common mistakes
- Using a single exceptional year’s growth to calculate PEG.
- Trusting forecast growth as if it were certain.
- Applying PEG to cyclical or loss-making companies.
A company has a P/E of 24 and EPS is growing 12% a year. What is its PEG?
- 2
- 0.5
- 288
Show the answer
2. PEG = P/E ÷ growth rate = 24 ÷ 12 = 2. You pay a P/E twice as high as the growth rate.
Common questions
What is a good PEG ratio?
A PEG near 1 is often called fair value and below 1 attractive, but this is only a rule of thumb. Check that the growth figure is realistic and sustainable.
Is PEG better than P/E?
It adds growth to the picture, which P/E lacks. But it depends on a growth estimate that can be wrong, so use both together rather than replacing one with the other.
Can PEG be negative?
Yes, if profit is falling. A negative PEG is not meaningful as a valuation and should not be read as cheap.
Practise reading company numbers, free
Short chapters, then real calls graded on your reasoning, not luck. No money involved.