The P/E ratio has a fatal flaw: it doesn't account for growth. A company trading at 40x earnings looks expensive, but if it's growing at 50% per year, it's actually cheap. The PEG ratio fixes this.
The Formula
PEG Ratio = P/E Ratio / Annual EPS Growth Rate
Example: Company A has a P/E of 30x and is growing earnings at 25% per year. PEG = 30 / 25 = 1.2x. Company B has a P/E of 15x but is growing at 5%. PEG = 15 / 5 = 3.0x. Company A is actually cheaper despite a higher P/E!
Interpreting the PEG
| PEG Range | Interpretation |
|---|---|
| < 0.5 | Potentially very undervalued |
| 0.5 – 1.0 | Undervalued for its growth rate |
| 1.0 – 1.5 | Fairly valued |
| 1.5 – 2.0 | Getting expensive |
| > 2.0 | Overvalued relative to growth |
PEG in Action: Real Companies
| Stock | P/E | Growth Rate | PEG | Verdict |
|---|---|---|---|---|
| Nvidia | 35x | 40% | 0.88 | Undervalued |
| Microsoft | 32x | 15% | 2.13 | Expensive |
| Meta | 23x | 22% | 1.05 | Fair value |
| Coca-Cola | 25x | 6% | 4.17 | Very expensive |
Limitations of PEG
- Relies on estimates: Forward growth rates are just analyst guesses
- Doesn't work for declining companies: Negative growth makes PEG meaningless
- Ignores quality: A PEG of 1.0 for a risky biotech isn't the same as PEG 1.0 for Microsoft
PEG Checklist
- Is the PEG below 1.5?
- Is the growth estimate based on consensus of 5+ analysts?
- Has the company actually achieved this growth rate historically?
- Is the growth rate sustainable (not a one-time spike)?
How Aristockrat Uses PEG
PEG is a core input in our Valuation Score, but we enhance it by using our own AI-generated growth estimates rather than relying solely on Wall Street consensus. This reduces the bias that analysts have toward companies they cover.