PEG ratio

The formula

• PEG = P/E / g

P/E is the price-earnings ratio and g the expected growth in earnings per share, in per cent a year. Dividing the one by the other asks how much the market pays for each point of growth.

A worked example

A share on a P/E of 15 whose earnings are expected to grow 10% a year: PEG = 15 / 10 = 1.5. A share on a P/E of 30 growing at 30% has a PEG of 1 and is, on this measure, cheaper. Turned round, a PEG of 1.5 with growth of 10% means a P/E of 15.

The yardstick of 1

Peter Lynch’s rule of thumb was that a share is fairly priced when the P/E equals the growth rate, a PEG of 1, cheap below and dear above. It is a rule of thumb: it treats a point of growth as worth a point of P/E whatever the interest rate, the risk or how long the growth lasts, which it is not. It does rank two growing companies more fairly than the P/E alone, which is what it is for.

Where the number comes from

The P/E is a fact; g is a forecast. Analysts’ estimates for the next one to five years are the usual source, and a PEG is only as good as that estimate. A company whose growth is expected to slow from 30% to 10% has a PEG that doubles without its price moving.

Common mistakes

• Using g as a decimal. The formula takes per cent: 10, not 0.10.
• Using historical growth as if it were expected. Past growth is a starting point for the estimate, not the estimate.
• Applying it to a company with no growth or a loss. With g at or below 0 the ratio has no meaning, and the card requires g above 0.

Frequently asked questions