PEG ratio
Price/Earnings to Growth ratio — the P/E ratio divided by the expected earnings growth rate, providing a valuation metric that accounts for growth.
Example
“A PEG ratio below 1.0 suggests a stock may be undervalued relative to its growth prospects.”
Memory Tip
PEG ratio = P/E divided by growth rate. Below 1 = potentially undervalued for its growth.
Why It Matters
The PEG ratio helps investors determine whether a stock is fairly valued relative to its growth potential, making it especially useful when comparing companies with different growth rates. Understanding this metric can prevent you from overpaying for stocks that appear cheap based on P/E ratio alone but have limited growth prospects.
Common Misconception
Many investors mistakenly believe that a lower P/E ratio always means a better investment, but the PEG ratio reveals that a stock with a low P/E might actually be expensive if its growth rate is also very low. This metric corrects that oversimplification by factoring growth into the valuation equation.
In Practice
Suppose Company A has a P/E ratio of 20 with an expected earnings growth rate of 25 percent annually, giving it a PEG ratio of 0.8, while Company B has a P/E ratio of 15 with only 5 percent expected growth, resulting in a PEG ratio of 3.0. Based on P/E alone, Company B looks cheaper, but the PEG ratio shows Company A is actually the better value because you are paying less per unit of growth.
Etymology
PEG = Price/Earnings divided by Growth. PEGGING the P/E ratio to the GROWTH rate.
Common Misspellings
Start investing with no commission trades
Related Terms
More in investing
Other investing terms you should know
See Also
Need financial definitions?
Clear definitions for 2,500+ finance, insurance, and investing terms.