The PEG ratio adjusts the P/E ratio for a company's expected earnings growth rate, providing a more complete valuation picture.
The PEG ratio improves upon the P/E ratio by factoring in expected growth. It divides the P/E ratio by the annual earnings growth rate, helping investors identify companies that may be undervalued despite having high P/E ratios due to strong growth prospects. A PEG ratio below 1.0 is generally considered attractive, suggesting the stock may be undervalued relative to its growth rate.
If a stock has a P/E ratio of 30 and earnings are expected to grow 20% annually, the PEG ratio is 30 / 20 = 1.5. A stock with P/E of 20 and 25% growth would have PEG of 20 / 25 = 0.8.
A PEG ratio above 2.0 suggests the stock may be overvalued even accounting for growth, or that growth expectations may not be realized.
A PEG ratio below 1.0 indicates the stock might be undervalued relative to its growth prospects, potentially representing a buying opportunity.
Generally, a PEG ratio around 1.0 is considered fair value, though this varies by market conditions and investor risk appetite.
