A P/E of 25 looks expensive compared to a P/E of 12. But if the first business is growing earnings at 30% per year and the second at 3%, the picture reverses. The PEG ratio captures this: it adjusts the P/E by the growth rate to show whether the premium is justified.
The formula
PEG Ratio = P/E Ratio ÷ EPS Growth Rate (%). A stock at P/E 20 growing at 20% per year has a PEG of 1.0. Peter Lynch considered PEG = 1.0 roughly fair value. Below 1.0: potentially undervalued for its growth. Above 2.0: likely overvalued for its growth.
| PEG | Lynch's interpretation |
|---|---|
| < 0.5 | Potentially very cheap relative to growth |
| 0.5 – 1.0 | Attractive — growth not fully priced in |
| 1.0 | Fair value — P/E matches growth rate |
| 1.0 – 2.0 | Paying a reasonable premium for quality |
| > 2.0 | Speculative — heavy optimism priced in |
Trailing PEG vs forward PEG
The growth rate used in the denominator changes the result dramatically. Trailing PEG uses historical EPS growth (what actually happened). Forward PEG uses analyst consensus estimates (what people expect). Lynch was sceptical of long-range forecasts — he generally used the last few years of actual growth as his anchor, sometimes blended with near-term estimates.
The danger of forward PEG: analysts systematically overestimate growth for popular, high-momentum companies. A stock can show an attractive forward PEG of 0.8 based on optimistic estimates, then disappoint and end up with a trailing PEG of 2.5. Use forward PEG as a sanity check, not a primary signal.
When PEG is most — and least — useful
- Most useful: mid-growth businesses growing 10–30% with consistent earnings history
- Less useful: early-stage companies with volatile or negative earnings
- Misleading: cyclicals where EPS swings wildly with commodity prices or the economy
- Irrelevant: income-focused dividend stocks where yield and payout ratio matter more than growth
PEG in historical context
Just as P/E is most useful compared to a stock's own history, PEG is most powerful when tracked over time. A technology company might always command a PEG of 1.5–2.5 because of its quality and consistency. When its PEG drops to 0.9, that's historically cheap for that specific business — even if Lynch's absolute threshold would call it fair value.
The GARP track in the Learning Center covers Peter Lynch's full framework — how he used PEG in practice, what else he looked for, and where the methodology breaks down.
Read: What is GARP? →