What is the PEG Ratio?

Definition: The PEG Ratio is a financial ratio for the valuation of stocks. It compares the PE (price to earnings ratio) of a stock with the anual earnings growth rate. With the PEG Ratio you can evaluate, whether a stock is cheap, fair or expensive in comparison to the promised growth rate of the company (EPS Growth = earnigns per share growth per annum).

 

PEG Ratio Calculation

        PE-Ratio           
   EPS Growth Rate

 

Example PEG Calculation:

A stock is valued at a PE of 12 and offers an anual EPS-Growth-Rate of 8% p.a. What's the PEG Ratio?

Answer: 1.5

 

The PEG Ratio in practice

The PEG Ratio says basically nothing else than: "a stock is fair priced, if the PE is about the same as the EPS-Growth-Rate p.a.

  • PEG 0-1 = attractive valuation
  • PEG close to 1 = fair valuation
  • PEG above 1 = expensive valuation

The PEG Ratio is a powerful valuation ratio but get's unfortunately often times ignored by investors. The PE alone does not give you the full picture about the valuation of a stock. Only after comparing the PE with the growth of a company the picture gets clear. A Stock with PE 25 and an EPS growth of%? Cheap! (PEG 0.83). A Stock with PE 17 und growth of 7%? Expensive! (2.42).

Investors looking for growth stocks with low PEG, do not risk to buy stocks with no earnings at all. Because these stocks have no PE (if they make losses) or a very high PE of 50-100, leading to a high PEG Ratio!