PEG Ratio

The PEG ratio is a stock’s P/E ratio divided by its expected annual earnings growth rate. It adjusts the raw multiple for growth, answering the question a bare P/E cannot: is this price expensive relative to what the business is becoming?

The math

A company at a P/E of 30 growing earnings 30 percent a year has a PEG of 1.0. Another at a P/E of 15 growing 5 percent has a PEG of 3.0.

On this lens the “cheaper” stock is the expensive one, and the arithmetic behind it is brutal: if the fast grower holds its trajectory for five years, its earnings multiply by 3.7 and today’s price becomes 8 times those future earnings, while the slow grower’s price still sits at 12 times its own.

	Fast grower	Slow grower
P/E today	30x	15x
Expected growth	30%/yr	5%/yr
PEG	1.0	3.0
P/E on year-5 earnings	8x	12x

The trap

The denominator is a forecast, usually analyst consensus, and consensus is most wrong exactly when it matters most: at inflection points. A PEG of 0.8 built on a growth estimate that never materializes is not a bargain, it is precision layered on sand.

High-growth assumptions also decay: very few companies compound earnings above 25 percent for a decade.

The move

Use the PEG as a sorting tool, never a verdict. It flags which expensive-looking stocks deserve a closer look and which cheap-looking ones are cheap for a reason.

Then do the real work on the denominator: how durable is the growth, what has to stay true for it to continue, and what happens to the price if growth merely halves.