Price/Earnings-to-Growth (PEG) Ratio: Definition and How To Calculate

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Everyone wants a crystal ball when it comes to investing. In reality, making smarter investment predictions is based on some basic math skills.

Understanding the PEG ratio or the price-to-earnings growth ratio can help investors identify which stocks are worth buying for long-term payoff.

It also helps accurately assess a stock’s value. When you watch the PEG ratio over time, you may see the ratio drop, signaling a good time to buy.

The PEG ratio improves on the classic P/E ratio by being forward-looking. This can make it a better tool for evaluating a company’s long-term prospects rather than its short-term value.

Here’s how to calculate the PEG ratio and how you can use it to help pick better stocks.

Understanding the PEG Ratio

What Is the PEG Ratio?

The price-to-earnings-growth ratio is designed to determine how overvalued or undervalued a stock may be based on its future earnings growth rate. It matters for investors because some high-growth stocks can be bid up to extraordinary valuations that set the stage for severe corrections. If a stock has an extremely high PEG, savvy investors can steer clear until such a correction occurs.

Similarly, the PEG ratio can be used to identify undervalued stocks, even when they seem to be overvalued by more traditional methods. For example, a stock with a P/E of 50 might seem to be overvalued to some investors, but if the underlying company has an extremely high growth rate, it can still actually be undervalued. The PEG ratio can help make this determination.

PEG Ratio Formula

To calculate the PEG ratio, first, you’ll need to compute a stock’s P/E ratio. This is simply a stock’s price divided by its earnings per share.

For example, if a stock trades at $50 and generates $2 in annual earnings per share, it has a P/E ratio of 25.

The PEG ratio takes this initial calculation and divides it further by a company’s earnings growth rate.

Here’s an example:

• Share price: $30
• Earnings per share in 2025: $1.50
• Earnings per share in 2024: $1.23

Second, calculate the P/E ratio. The stock’s share price of $30 divided by its current earnings of $1.50 gives it a P/E of 20.

Finally, divide the P/E ratio by the earnings growth rate. From 2024 to 2025, the earnings for this company grew by 21.95%. So, the P/E ratio of 20 divided by the earnings growth rate of 21.95 gives a PEG of 0.911.

PEG Ratio Formula (With Example)

1. Find the earnings per share.
   • Example: In 2025, the company earned $1.50 per share, up from $1.23 per share in 2024.
2. Calculate the P/E ratio.
   • Formula: P/E = Stock Price / EPS
   • Example: If the stock price is $30 and EPS is $1.50, then:
     P/E = 30 / 1.50 = 20
3. Determine the earnings growth rate.
   • Formula: (New EPS – Old EPS) / Old EPS x 100
   • Example: (1.50 – 1.23) / 1.23 x 100 = 21.95%
4. Calculate the PEG ratio.
   • Formula: PEG = P/E / Growth Rate
   • Example: 20 / 21.95 = 0.911

A PEG ratio below 1 suggests the stock may be undervalued, while a PEG above 1 suggests it may be overvalued relative to its growth.

Interpreting the PEG Ratio

What Is a Good PEG Ratio?

Generally, the lower a PEG ratio, the more undervalued a stock is. Here is how investors typically evaluate a PEG ratio:

• PEG < 1: Potentially undervalued stock
• PEG = 1: Fairly valued stock
• PEG > 1: Potentially overvalued stock

PEG Ratio vs. P/E Ratio

While P/E ratios are useful, they are limited to providing current information only. They don’t incorporate the earnings growth rate of a company, as the PEG ratio does, and they don’t provide any type of analysis of a company’s financials. A company on the brink of bankruptcy, for example, may have a low P/E; however, this may be because the stock has fallen rapidly ahead of an upcoming earnings collapse.

The PEG ratio attempts to avoid some of the problems with the P/E ratio by incorporating the actual earnings growth rate of a company. In essence, a PEG ratio can help determine if a company’s share price is racing ahead of its earnings growth, making it overvalued, or whether it is still catching up to its growth rate, making it undervalued.

It’s important to note, however, that the P/E ratio itself is used in the calculation of the PEG ratio. This means that a faulty or misleading P/E can diminish the value of the PEG ratio as well.

PEG Ratio vs. Other Valuation Metrics

Two other popular valuation metrics, beyond PEG and P/E ratios, are price-to-sales (P/S) and price-to-book (P/B) ratios.

The P/S ratio compares a company’s price to its revenue rather than to its earnings. Some investors prefer to use this ratio to value high-growth stocks that are generating high levels of revenue but are also spending a lot of money expanding. The theory is that, over time, profits will catch up with sales. In the meantime, investors are willing to pay for the company’s high sales growth rate. This makes P/S ratios popular with high-flying tech companies that haven’t yet translated their revenue into profits.

The P/B ratio, on the other hand, is generally used to value large, capital-intensive companies that have much of their value tied up in their equipment and inventory. Book value is sometimes called net asset value or intrinsic value. Some investors use the P/B ratio to see how expensive a company’s stock is to the “real” value of a company. This makes it relatively useless for companies with intangible assets, like software companies.

Advantages and Limitations of the PEG Ratio

Advantages

• Factors in earnings growth rates, unlike the P/E ratio
• Particularly helpful in comparing growth stocks
• Helps identify undervalued opportunities with a simple system, where PEG ratios under 1 generally indicate attractively valued stocks

Limitations

• Relies on future earnings estimates, which may be inaccurate
• Different industries have different PEG standards
• Doesn’t account for risk or capital structure, such as how much cash a company keeps on hand that could propel future growth

Real-World Examples of PEG Ratio Analysis

1. Evaluating a High-Growth Tech Stock

PEG ratios are best used when assessing high-growth stocks, like those in the technology industry. This is because these types of stocks often have a combination of high growth rates and high P/E ratios. On a strict P/E ratio basis, many tech stocks, like Nvidia, would seem to be overvalued. But the PEG ratio can tell a different story. As of Jan. 31, 2024, Nvidia had a trailing P/E of 81.17 and a forward P/E of 30.40, both very high valuations. But at the time, its PEG ratio was just 0.60, indicating it was very undervalued, according to Yahoo. Those who bought the stock on Jan. 31, 2024, and held it for one year were rewarded with a gain of more than 100%.

2. Comparing PEG Ratios Across Industries

PEG ratios vary across differing industries, meaning you can’t make apples-to-apples comparisons. For example, high-growth industries like technology often have high PE and PEG ratios, while slower-growing sectors like utilities or air transport have correspondingly lower ratios. To get the most value out of a PEG ratio comparison, stick within the same industry to determine relative valuations.

3. PEG in Bear vs. Bull Markets

By definition, investors are more euphoric in bull markets, and valuations of individual stocks get stretched. This translates to higher PEG ratios during bull markets and lower ones during bear markets. This is an important factor to keep in mind when evaluating stocks. In a raging bull market, a PEG slightly above 1 may still represent a good value, particularly if competitors in the same industry are trading at higher levels. The opposite can also be true. Most stocks are “values” when in a bear market, but they aren’t likely to rally until the market as a whole reverses its trend.

Emily Cahill contributed to the reporting for this article.

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