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What Is the PEG Ratio? Formula, Meaning and Example
The PEG ratio adjusts the P/E ratio for earnings growth. Learn the formula, see a worked example and understand what a PEG below or above 1 means.
PEG ratio in 60 seconds
- The PEG ratio divides the P/E ratio by the company's expected earnings growth rate.
- Formula: P/E ÷ annual EPS growth (in %).
- As a rule of thumb, a PEG near or below 1 suggests you are not overpaying for growth — but it depends entirely on how realistic the growth estimate is.
Educational summary — not investment advice.
A high P/E is not automatically expensive: a company growing profits at 30% a year deserves a higher multiple than one growing at 5%. The PEG ratio — Price/Earnings to Growth — builds that growth into the valuation.
It answers a simple question: how much am I paying for each percentage point of earnings growth?
How is PEG ratio calculated?
| Measure | Formula |
|---|---|
| PEG ratio | P/E ratio ÷ Expected annual EPS growth rate (%) |
| EPS growth rate | (EPS this year − EPS last year) ÷ EPS last year × 100 |
Use a growth rate you can defend: a multi-year earnings CAGR from past results or a reasonable analyst estimate, rather than one exceptional year.
PEG ratio example with numbers
| Item | Value |
|---|---|
| Company A: P/E | 30.0x |
| Company A: expected EPS growth | 20% |
| Company A: PEG | 1.50 |
| Company B: P/E | 20.0x |
| Company B: expected EPS growth | 25% |
| Company B: PEG | 0.80 |
Company A looks expensive next to B on P/E alone (30.0x vs 20.0x) and its PEG of 1.50 says the same: you pay more per unit of growth. Company B, with a PEG of 0.80, is the cheaper way to buy growth — assuming its growth estimate holds.
PEG of 1, a common rule of thumb: 1.00
Illustrative figures. Lower means less is paid per point of growth — if the growth estimate holds.
How to read the PEG ratio
- Around 1: price and growth are roughly in line — a common rule of thumb for 'fairly valued'.
- Below 1: growth looks cheap relative to the multiple, or the market doubts the growth estimate.
- Above 2: you are paying a lot for the expected growth — there is little room for disappointment.
Limitations
PEG is only as reliable as the growth number behind it, and growth estimates are frequently wrong. It also works poorly for companies with erratic or negative earnings, for cyclical businesses whose profits swing with the economy, and for slow-growth dividend payers.
Treat 1 and 2 as rules of thumb rather than rules. Use PEG to shortlist and compare, then confirm with cash flow, debt and the quality of the business.
The problem PEG was invented to solve
Imagine two stocks. One trades at a P/E of 15 and its profits are growing at 5% a year. The other trades at a P/E of 30 and its profits are growing at 40%. Which is cheaper? On P/E alone the first looks half the price. But if the second company keeps growing at that pace, its earnings will double in under two years, and the P/E on those future earnings would fall quickly.
The PEG ratio — P/E divided by the growth rate — was designed to compare exactly this kind of pair. It converts the question from "how much do I pay for a rupee of earnings?" into "how much do I pay for a rupee of earnings, given how fast those earnings are growing?" It is a simple idea, popularised by fund managers looking for growth at a reasonable price.
Calculating PEG in three steps
- Step 1: get the P/E. Use price divided by trailing consolidated EPS, or forward P/E if you trust the estimates.
- Step 2: estimate the growth rate. Use the compound annual growth rate (CAGR) of EPS over three to five years, or a cautious estimate of the next few years. Express it as a whole number, so 20% becomes 20.
- Step 3: divide. PEG = P/E ÷ growth rate.
Say a stock has a P/E of 28. Its EPS was ₹10 five years ago and is ₹20 today. The five-year growth rate is (20 ÷ 10)^(1/5) − 1, which is about 14.9%. PEG = 28 ÷ 14.9 = 1.9. If analysts instead expect 25% growth, PEG falls to 28 ÷ 25 = 1.1. The same stock looks expensive or fair depending entirely on the growth assumption — and that is the central weakness of PEG.
How sensitive PEG is to the growth number
Because growth sits in the denominator, small changes in the assumption move PEG a lot. The table shows one stock with a fixed P/E of 30 under different growth assumptions.
| Assumed EPS growth | PEG |
|---|---|
| 10% | 3.0 |
| 15% | 2.0 |
| 20% | 1.5 |
| 30% | 1.0 |
| 40% | 0.75 |
Nothing about the company or its price has changed between the rows; only the story about its future has. A low PEG is therefore only as trustworthy as the growth forecast behind it. Prefer a growth rate the company has already delivered over several years to an optimistic estimate for the next one.
Where PEG works, and where it misleads
| Situation | Is PEG useful? |
|---|---|
| Steady growers with a record of consistent EPS growth | Yes — the historical growth rate is a reasonable guide. |
| Fast-growing mid and small caps | Yes, cautiously — growth may fade sooner than estimates assume. |
| Cyclical companies (metals, sugar, cement) | No — EPS growth at a cycle peak or recovery says nothing about the future. |
| Loss-making companies | No — there is no positive P/E to divide. |
| Very low growth or dividend-focused companies | Rarely — a PEG of 5 or more is mathematically meaningless here. |
| Companies whose profit is boosted by one-off items | No — growth from a one-time gain will not repeat. |
Two stocks, one lesson
Consider Company X with a P/E of 40 and EPS growth of 35%, and Company Y with a P/E of 18 and EPS growth of 8%. Their PEGs are 40 ÷ 35 = 1.14 for X and 18 ÷ 8 = 2.25 for Y. X, the "expensive" stock, is actually the cheaper way to buy growth.
But add a second layer of questions. How long can X sustain 35% growth? A business that grows profits at that pace for ten years will be enormous, so growth almost always slows. If it slows to 20% in two years, X's PEG rises to 2.0 at the same price. Meanwhile Y's slow, dependable growth may prove more durable. PEG tells you the price of growth; it cannot tell you how long the growth will last.
Good habits when using PEG
- Use PEG to shortlist and compare, never as the only reason to buy.
- Cross-check the growth rate against revenue growth. If EPS is growing much faster than revenue for years, margins or buybacks are doing the work and that cannot continue forever.
- Look at the quality of growth: is it funded by rising debt or by retained profits?
- Compare PEG within a sector; norms differ between banks, FMCG and IT.
Test yourself
- Question 1. A stock has a P/E of 24 and expected EPS growth of 12%. What is the PEG? Answer: 24 ÷ 12 = 2.0.
- Question 2. Same stock, but growth is expected to be 24%. Answer: 24 ÷ 24 = 1.0.
- Question 3. EPS grew from ₹8 to ₹16 over 4 years. Roughly what is the annual growth rate? Answer: (16 ÷ 8)^(1/4) − 1 ≈ 18.9%, so about 19% a year.
Pair PEG with the P/E ratio for the price side, and with return on equity to check that the growth is being generated efficiently.
On NSE and BSE: what to keep in mind
- Take EPS growth from the consolidated results filed on NSE and BSE, and prefer a 3 to 5 year growth rate over one strong year.
- Indian mid and small caps often carry high P/Es on the back of fast growth. PEG helps separate real growth from hype, but growth estimates for smaller companies are the least reliable.
- Cyclical sectors such as metals, cement and sugar can show a flattering PEG at the top of a cycle — be careful.
PEG ratio: frequently asked questions
What is a good PEG ratio?
Many investors look for a PEG at or below 1, but the right level depends on the sector and on how dependable the growth is. Compare PEG among similar companies.
Which growth rate should I use for PEG?
Use a realistic forward EPS growth estimate or a multi-year earnings CAGR. A single unusually strong year will make PEG look better than it is.
Can PEG be used for every stock?
No. It is meaningless for loss-making companies and unreliable for cyclicals and for businesses with very low or unstable growth.
Disclaimer: this article is for education only. The figures in the worked example are illustrative and do not describe any real company listed on NSE or BSE. It is not investment advice, and investingg.in is not a SEBI-registered advisor.
The bottom line
P/E tells you the price; PEG tells you whether the growth justifies it. Use it to compare growth stocks — and be honest about how solid the growth assumption really is.
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Disclaimer: This analysis is for educational purposes only and should not be considered investment or trading advice. Please consult your financial advisor before making investment decisions.