What is PEG Ratio? How Growth Adjusts the PE Ratio
PEG divides PE by growth rate to find if you are overpaying for growth.
The PEG ratio divides a stock's P/E ratio by its earnings growth rate. It adjusts the P/E for growth, helping you determine if a high P/E is justified by high growth. A PEG of 1 means the P/E equals the growth rate. Below 1 suggests the stock may be undervalued relative to its growth.
A stock with P/E of 30 looks expensive. But if its earnings are growing at 30% annually, PEG is 1.0 (30/30). Another stock with P/E of 15 growing at 8% has PEG of 1.87. The high P/E stock is actually cheaper relative to its growth. PEG reveals what P/E alone cannot.
PEG Ratio = P/E Ratio / Annual EPS Growth Rate (%)
If a stock has P/E of 25 and EPS growth rate of 20%: PEG = 25 / 20 = 1.25
What PEG values indicate good value?
Below 1: potentially undervalued relative to growth. Around 1: fairly valued for its growth rate. Above 1.5: potentially overvalued unless growth accelerates. Above 2: expensive unless the company has exceptional moats. Peter Lynch popularised PEG below 1 as a buying criterion.
What growth rate should I use?
Historical 3 to 5 year EPS CAGR is most common. Projected future growth rate is forward-looking. Using the past 3-year growth rate is safer because it is actual data. Using projected growth introduces estimation error. Conservative investors use the lower of past and projected growth.
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Frequently Asked Questions
Is PEG useful for all types of companies?
Best for growth companies. Not useful for cyclical companies (growth rates fluctuate wildly), loss-making companies (no meaningful P/E), or mature companies with low growth (PEG becomes very high). Stick to stable-growth companies for meaningful PEG analysis.
Can PEG be negative?
Yes, if either P/E or growth rate is negative. A negative PEG is meaningless. If growth is negative (earnings declining), P/E divided by negative growth gives a negative PEG. In such cases, PEG is not applicable.
How does PEG compare to plain P/E?
P/E tells you what you pay per rupee of earnings. PEG tells you what you pay per unit of growth. P/E alone can be misleading because it does not account for growth differences. PEG normalises this difference. Always use PEG alongside P/E, not as a replacement.
Which Indian stocks have attractive PEG ratios?
Companies growing earnings at 20%+ with P/E below 20 often have attractive PEGs. Some mid-cap IT, pharma, and specialty chemical companies occasionally reach PEG below 1. These opportunities are temporary because the market eventually recognises the value.
What are the limitations of PEG?
Assumes growth will continue at the used rate, which may not happen. Does not account for quality of growth (debt-funded vs organic). Does not consider balance sheet risk. Works best as a screening tool, not a standalone valuation method.
Investments in securities market are subject to market risks. This article is for educational purposes only and does not constitute investment advice.
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