PEG Ratio
The PEG ratio divides a stock's P/E ratio by its expected annual earnings growth rate, adjusting valuation for growth.
A high P/E ratio does not necessarily mean a stock is overpriced if the company is growing quickly. The price/earnings-to-growth ratio, or PEG, tries to account for that. The formula is the P/E ratio divided by the expected annual growth rate of earnings per share, expressed as a whole number.
Example: a company has a P/E of 30 and earnings expected to grow 20% a year. Its PEG is 30 divided by 20, or 1.5. Another company with a P/E of 15 and 5% growth has a PEG of 3.
As a rough rule of thumb popularized by investor Peter Lynch, a PEG around 1 is sometimes viewed as fair value, below 1 as potentially attractive, and well above 1 as expensive relative to growth. These are guidelines, not rules.
The PEG has clear limitations. It depends heavily on growth estimates, which may be inaccurate. It ignores dividends, debt and risk, and it does not work for companies with negative earnings or no growth. Different sources use different growth periods, so PEG values are best compared when calculated the same way.