Consultant

What Is a Good PEG Ratio for a Stock? PEG Ratio Defined

April 6, 2025

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The price/earnings-to-growth ratio, or PEG ratio, is a stock valuation metric that combines a company’s price-to-earnings (P/E) ratio with its earnings growth rate over a set period. Unlike the P/E ratio, which focuses only on current earnings, the PEG ratio provides a broader perspective by factoring in future growth expectations.

The PEG ratio is widely used by investors and analysts to assess the overall performance and evaluate the potential risk of an investment.

In theory, a PEG ratio of 1.0 indicates that the market value of the stock is aligned with its projected earnings growth. A ratio above 1.0 suggests the stock may be overvalued, while a ratio below 1.0 is generally considered favorable, indicating that the stock may be undervalued.

Key Takeaways

The price/earnings-to-growth ratio, or PEG ratio, is a valuation metric that factors in both price and expected earnings growth.
A PEG ratio under 1.0 may indicate an undervalued stock, potentially signaling a buying opportunity.
A PEG ratio above 1.0 may suggest the stock is overvalued.
The PEG ratio is more comprehensive than the P/E ratio because it includes growth forecasts.
Always be mindful of the time frame used for growth projections when interpreting the PEG ratio.

PEG Ratio vs. P/E Ratio

The price-to-earnings (P/E) ratio gives analysts a good fundamental indication of what investors are currently paying for a stock in relation to the company’s earnings. However, the P/E ratio doesn’t account for future growth potential. The PEG ratio represents a fuller—and hopefully—more accurate valuation measure than the standard P/E ratio.

The PEG ratio builds upon the P/E ratio by factoring growth into the equation. Factoring in future growth adds an important element to stock valuation since equity investments represent a financial interest in a company’s future earnings.

Important

The PEG ratio will differ if you use trailing P/E versus forward P/E. Be consistent and aware of which version of P/E is used.

Calculating the PEG Ratio

To calculate a stock’s PEG ratio you must first figure out its P/E ratio. The P/E ratio is calculated by dividing the per-share market value by its per-share earnings. From here, the formula for the PEG ratio is simple:

$begin{aligned} &text{PEG}=frac{text{P/E}}{text{EGR}}\ &textbf{where:}\ &text{EGR = Earnings growth rate over five years}\ end{aligned}$

Where:

P/E is the price-to-earnings ratio (market price per share divided by earnings per share).
EGR is the earnings growth rate over a specified period (typically 5 years).

While you can use different periods for the growth rate, it’s important to note that projections farther out in time tend to be less accurate.

Example of the PEG Ratio

If you’re choosing between two stocks from companies in the same industry, then you may want to look at their PEG ratios to make your decision. For example, the stock of Company Y may trade for a price that’s 15 times its earnings, while Company Z’s stock may trade for 18 times its earnings. If you simply look at the P/E ratio, then Company Y may seem like the more appealing option.

However, Company Y has a projected five-year earnings growth rate of 12% per year while Company Z’s earnings have a projected growth rate of 19% per year for the same period. Here’s what their PEG ratio calculations would look like:

$begin{aligned} &text{Company Y PEG = 15/12% = 1.25}\ &text{Company Z PEG = 18/19% = 0.95}\ end{aligned}$

This shows that when you take possible growth into account, Company Z could be the better option because it’s actually trading for a discount compared to its value.

Other Factors to Consider

The PEG ratio doesn’t take into account other factors that can help determine a company’s value. For example, the PEG doesn’t look at the amount of cash a company keeps on its balance sheet, which could add value if it’s a large amount.

Other factors analysts consider when evaluating stocks include the price-to-book ratio (P/B) ratio. This can help them determine if a stock is genuinely undervalued or if the growth estimates used to calculate the PEG ratio are simply inaccurate. To calculate the P/B ratio, divide the stock’s price per share by its book value per share.

Is a High or Low PEG Ratio Better?

In general, a low PEG ratio is preferred, especially if it’s below 1.0. A PEG below 1.0 suggests that the stock is undervalued relative to its expected growth. On the other hand, a high PEG ratio (above 1.0) indicates that the stock may be overvalued, with its price not adequately supported by projected earnings growth.

What Does a Negative PEG Ratio Mean?

A negative PEG ratio can occur when the P/E ratio is negative (usually because the company is losing money) or if the growth rate is negative. Either scenario suggests that the company is struggling financially or is expected to have declining earnings, making it a less favorable investment.

What Are Some Limitations of the PEG Ratio?

Getting an accurate PEG ratio depends highly on what factors are used in the calculations. Investors may find that PEG ratios are inaccurate if they use historical growth rates, especially if future ones may deviate from the past. In order to make sure the calculations remain distinct, the terms “forward” and “trailing” PEG are often used.

The Bottom Line

The PEG ratio is a valuable metric for assessing a company’s stock price in relation to its expected earnings growth. It offers a more complete picture than the P/E ratio, which only looks at current earnings without considering future potential. A PEG ratio below 1.0 is typically seen as an indication of an undervalued stock, while a ratio above 1.0 could signal overvaluation.

However, like all financial metrics, the PEG ratio should not be used in isolation. It’s best to consider it alongside other valuation measures and factors to gain a well-rounded understanding of a stock’s investment potential.

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