PEG Ratio
P/E divided by expected earnings growth rate (in percentage points). Peter Lynch's heuristic for whether a stock's P/E is justified by its growth profile: PEG ≈ 1 is fair, < 1 is cheap, > 1 is expensive.
When to use: Use as a quick growth-adjusted valuation read. PEG normalizes P/E by growth, letting a 30× P/E grower be compared on equal footing with a 12× P/E mature business. Most useful for genuine growth companies; less useful for mature, low-growth names.
Formula
Variables
| Symbol | Name | Description | Unit |
|---|---|---|---|
| PEG | PEG Ratio | P/E divided by growth (in percent points) | integer |
| PE | P/E Ratio | Price-to-earnings multiple | integer |
| GrowthPct | Growth Rate (%) | Annual growth rate in percent points (e.g. 12 for 12%) | integer |
Real-Life Examples
Example 1: 30× P/E, 25% Growth
A growth stock trades at 30× earnings with expected EPS growth of 25% per year.
Given
Step-by-Step
PEG of 1.2 — fair-to-slightly-expensive by Lynch's rule of thumb. The market is paying a small premium beyond pure growth justification, possibly for quality, durability, or scarcity of similar opportunities.
Example 2: 15× P/E, 18% Growth
A mid-cap trades at 15× earnings with 18% expected growth.
Given
Step-by-Step
PEG of 0.83 — Lynch's definition of cheap. Either growth is being underestimated by the market or there is something offsetting (cyclical risk, debt, declining moat) holding the multiple down.
Frequently Asked Questions
It's a heuristic, not a rigorous valuation. The PEG = 1 rule comes from Lynch's observation that investors should rarely pay more than the growth rate for a P/E. The more rigorous rule is "PEG that produces an entry P/E giving the required return given exit P/E" — see the Entry P/E formula.
Convention — PEG was popularized by Lynch using the 1-to-1 mental model: "a 20% grower deserves a 20× P/E." Dividing the P/E by the growth-percent gives the dimensionless ratio that the rule requires.
For low-growth or no-growth companies (denominator approaches zero, PEG explodes), for cyclicals (growth varies wildly by cycle stage), and for companies where growth is bought via heavy reinvestment (high P/E with low capital efficiency masks the true picture).