6.9What is the PEG ratio?
1What is it?
PEG adjusts the P/E ratio for expected profit growth.
2Why does it exist?
A high P/E may be fine if profits are growing fast. PEG lets you compare fast-growers and slow-growers more fairly.
3Diagram
High value means…
Paying a lot for each unit of growth (above 2 is often considered expensive).
Low value means…
Growth may be underpriced (around 1 or below is often considered reasonable).
Is high or low good?
Lower is generally better, if growth estimates are realistic.
4Calculation
PEG = P/E ÷ Annual EPS growth rate (%)
- Company A: P/E 40, growth 40% → PEG = 1.0.
- Company B: P/E 20, growth 5% → PEG = 4.0.
A looks more reasonably priced for its growth than B.
5Risks
- Depends on growth forecasts, which are often wrong.
- Meaningless for low or negative growth.
6Practical use
Always compare a ratio with (1) the company’s own history and (2) other companies in the same industry. A single number on its own means little.
7Quick revision
- PEG = P/E ÷ growth %.
- ~1 considered fair.
- Only as good as the growth estimate.
8Knowledge check
Q1. P/E 30, growth 15%. PEG?Show answer
2.
Q2. Why use PEG instead of P/E?Show answer
It accounts for growth.
Q3. Main weakness?Show answer
Growth forecasts are uncertain.