PEG (Price/Earnings to Growth ratio)
PER divided by the earnings growth rate — a measure that looks at the share price level while factoring in the pace of growth.
PEG = PER ÷ annual EPS growth rate (%)
Generally, below 1 is seen as a multiple that is low relative to growth, 1 as balanced, and above 1 as a multiple that is high relative to growth (Lynch's yardstick).
In plain terms
Looking at PER alone, fast-growing companies always appear to carry a high multiple (a large expected future profit means a higher PER is assigned).
PEG divides PER by the company's earnings growth rate to see "whether the multiple is high once the pace of growth is taken into account." For example, even at a PER of 30, if earnings grow 30% each year, the PEG is 1. It is a measure Peter Lynch liked to use.
What it tells you
It gauges whether a fast-growing company's high PER is warranted in light of that growth.
With PER alone it is easy to stop at "growth stocks carry high multiples," but PEG puts growth in the denominator so you can consider whether the multiple is large relative to that growth.
Formula
PEG = PER ÷ annual EPS growth rate (%)
What high or low means
Generally, below 1 is seen as a multiple that is low relative to growth, 1 as balanced, and above 1 as a multiple that is high relative to growth (Lynch's yardstick).
That said, the value changes greatly depending on which growth rate you use, so it is hard to treat it as an absolute standard.
PEG is very sensitive to assumptions about future growth. The value changes a lot depending on whether you use past growth or estimated growth.
If growth is zero or the company is at a loss, the calculation is meaningless, and very high growth rates are hard to sustain for long, so a low PEG does not immediately mean the price is low.
Peter Lynch, the "hero of Wall Street," is famous as the person who popularized PEG. He ran the Magellan Fund from 1977 to 1990 with a remarkable average annual return of about 29%, and when picking growth stocks he liked to use the standard that "if PER equals the growth rate (PEG = 1), it is fair."
No matter how fast a company grows, if its PER is far above its growth rate (PEG well over 1), he saw it as paying too much. It is an indicator that carries the wisdom of looking at growth and price together, guarding against paying a high price while intoxicated by rapid growth.
Metrics to read alongside
See it in real stocks
Search US stocks on Stocklore to see SEC-filing-based financial metrics alongside the sector benchmark.
This explanation is for information and reference only and is not a recommendation to buy or sell any security. Investment decisions and their consequences are your own.