The PEG ratio is P/E divided by the earnings growth rate. That's it. Yet the simplicity is deceptive — it captures something that the raw P/E completely misses.
The formula and what it means
PEG = P/E ratio ÷ EPS growth rate (%). A stock with a P/E of 25 and an earnings growth rate of 25% has a PEG of 1.0. Peter Lynch considered PEG = 1.0 to be "fairly valued" — a reasonable price to pay for the growth you're getting. Below 1.0 is potentially cheap. Above 2.0 is expensive relative to growth.
| Scenario | P/E | Growth Rate | PEG | Lynch's view |
|---|---|---|---|---|
| Growth stock, fairly priced | 20× | 20% | 1.0 | Fair |
| Value trap disguised as growth | 12× | 4% | 3.0 | Expensive for growth |
| GARP opportunity | 18× | 25% | 0.72 | Potentially cheap |
| Speculation | 50× | 20% | 2.5 | Paying too much for growth |
Notice the second row: a company with a P/E of 12× looks cheap in isolation. But if it's growing at only 4%, a GARP investor would see the PEG at 3.0 and consider it quite expensive relative to what the growth delivers.
Forward PEG vs trailing PEG
The growth rate used matters enormously. Trailing PEG uses historical EPS growth — it's what actually happened. Forward PEG uses analysts' earnings estimates — it's what people expect to happen. Lynch generally favoured trailing or near-term estimates, being sceptical of forecasts beyond 3–5 years.
The danger of forward PEG is that analysts systematically overestimate growth, particularly for popular companies with good recent momentum. A stock with an attractive forward PEG might turn out to be expensive when the actual earnings come in below expectations.
PEG in context: the same principle as P/E history
Just as P/E is most useful compared to a stock's own history (not an absolute threshold), PEG is most useful as a relative tool. A technology company might always trade at a PEG of 1.5–2.5 because of its business quality. When its PEG drops to 1.0, that's historically cheap for that specific company — even if 1.0 is "fair" in Lynch's framework.
What PEG doesn't tell you
- Quality of earnings: high-growth EPS driven by buybacks or accounting adjustments is not the same as organic earnings growth.
- Duration of growth: a company growing at 25% now might revert to 10% in 3 years. PEG assumes the current rate is sustainable.
- Balance sheet risk: a business growing rapidly while accumulating debt is a very different situation from one funding growth from free cash flow.
- Dividend income: PEG is almost entirely irrelevant for income-focused investors; yield and yield history matter far more.
Each stock page on Sixtycents shows PEG alongside its historical percentile — so you can see not just the raw PEG, but whether it's cheap or expensive relative to where the stock has historically traded.
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