PEG Ratio Formula
PEG ratio = P/E ratio ÷ annual EPS growth rate (growth entered as a whole number, e.g. 20 not 0.20). A company with a P/E of 30 and expected EPS growth of 20%: 30 ÷ 20 = 1.5 PEG. PEG asks how much valuation you're paying for each percentage point of expected earnings growth.
Common PEG Interpretations
| PEG | Rough read |
|---|---|
| Below 1.0 | Potentially inexpensive relative to growth |
| Around 1.0 | Valuation and growth roughly aligned |
| 1.0–2.0 | Moderate premium |
| Above 2.0 | Potentially expensive relative to growth |
These are not universal rules. A high-quality business with recurring revenue, high returns on capital, and predictable growth may deserve a PEG above 2.0. A low-quality cyclical business may deserve a PEG below 1.0 because its projected growth isn't sustainable.
Worked Example: Two Companies
Company A: forward P/E 24, expected EPS growth 12% → 24 ÷ 12 = 2.0 PEG. Company B: forward P/E 36, expected EPS growth 30% → 36 ÷ 30 = 1.2 PEG. Company B has a higher P/E but a lower PEG because expected earnings growth is substantially higher — that doesn't automatically make it the better investment; its growth forecast may be riskier or less durable.
Why Growth Estimate Quality Matters
PEG is only as reliable as the growth estimate feeding it. Growth projections fail because of economic slowdown, competitive pressure, margin compression, customer losses, higher interest expense, share dilution, or plain analyst over-optimism. A precise-looking PEG can create false confidence when the underlying forecast is uncertain — and PEG is generally not meaningful when expected growth is negative, near zero, or recovering from an unusually depressed comparison period (earnings rising from $0.10 to $0.50 is "400% growth" that overstates normalized momentum).
EPS growth used in the PEG calculation can also come from share repurchases rather than the business itself: net income up 4% with shares outstanding down 6% can produce ~10% EPS growth — making the PEG look better than the underlying business improvement warrants. Compare net-income growth, EPS growth, and share-count growth side by side before trusting the ratio.
PEG Analysis Checklist
Review the P/E type used (trailing or forward), the EPS definition, the growth period and source, analyst estimate range, revenue growth, margin trend, FCF growth, buybacks vs. dilution, and cyclicality. Red flags: PEG based on one unusually strong year, growth driven mainly by buybacks, an earnings recovery from a depressed base, and different calculation methods across the companies you're comparing.
Frequently Asked Questions
What does a PEG ratio of 1 mean?
A PEG of 1 means the numerical P/E ratio equals the expected annual EPS growth percentage under the conventional calculation.
Is a PEG below 1 always good?
No. It may indicate attractive valuation, but it may also reflect unreliable growth forecasts, cyclicality, or business risk.
Is PEG better than P/E?
PEG adds growth context, but it depends more heavily on estimates. The two ratios should be used together.
Can PEG be negative?
A mathematically negative PEG may result from negative growth or earnings, but it is generally not useful for conventional valuation analysis.
What growth rate should be used for PEG?
Investors may use one-year, three-year, or five-year expected EPS growth. The period and source should remain consistent when comparing companies.