Investology > PEG Ratio

PEG Ratio

  • Posted byby Marko N.
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PEG Ratio (Price/Earnings-to-Growth) is a valuation metric that compares a company's P/E ratio to its expected earnings growth rate, revealing whether a stock's price is justified by its growth prospects. A PEG of 1.0 is considered fairly valued - you're paying $1 in P/E for every 1% of growth. Below 1.0 suggests potential bargains. Anything over 2 is overvalued.

PEG Ratio (Price/Earnings-to-Growth) is a valuation metric that compares a company’s P/E ratio to its expected earnings growth rate, revealing whether a stock’s price is justified by its growth prospects.

Think of PEG as the stock market’s reality check – it’s like asking “Sure, this stock is expensive, but is it expensive enough given how fast it’s growing?” It separates the legitimately hot growth stocks from the overpriced pretenders. Not to be confused with PEG, which presents the same picture but from the cost side rather than growth side.

PEG Ratio = P/E Ratio / Annual Earnings Growth Rate (%)

Why PEG Ratio Matters in Stock Analysis:

  • Growth-Adjusted Valuation: Unlike P/E alone, PEG accounts for growth speed, making a $100 stock with 50% growth look cheaper than a $20 stock with 5% growth.
  • Fair Value Sweet Spot: A PEG of 1.0 is considered fairly valued – you’re paying $1 in P/E for every 1% of growth. Below 1.0 suggests potential bargains. Anything over 2 is overvalued.
  • Hype Detector: Helps identify when “growth stories” are actually just expensive stocks with mediocre growth prospects masquerading as the next big thing.
  • Cross-Sector Comparisons: Allows apples-to-apples comparisons between a tech rocket ship and a steady utility company by normalizing for growth expectations.

Example: NVIDIA (NASDAQ: NVDA) trades with a P/E of 65 and analysts expect 25% annual earnings growth driven by AI demand. The PEG becomes 2.6 (65 ÷ 25), suggesting investors are paying a hefty premium for the AI gold rush. Whether that premium holds depends on sustained AI adoption.

Bottom Line: PEG Ratio is the growth investor’s best friend, helping distinguish between expensive-but-worth-it growth stocks and expensive-because-overhyped disappointments waiting to happen.