The PEG (Price/Earnings to Growth) ratio is a valuation metric used to determine if a company's stock price is overvalued or undervalued, taking into account its earnings growth. It improves upon the traditional Price-to-Earnings (P/E) ratio by incorporating the expected future earnings growth, offering a more comprehensive view of a stock's value relative to its growth potential.

Formula

PEG Ratio = Price/Earnings (P/E) Ratio / Annual Earnings Per Share (EPS) Growth Rate. The P/E Ratio (Price per Share / Earnings Per Share) indicates how much investors are willing to pay for each dollar of a company's earnings. The Annual EPS Growth Rate represents the projected percentage increase in a company's earnings per share over a specific future period, usually the next 12 months.

Why is it Important for Investors?

Investors care about the PEG ratio because it provides a more nuanced picture of a company's valuation than the P/E ratio alone. While a low P/E might seem appealing, it doesn't tell you if that low P/E is justified by stagnant growth. The PEG ratio helps identify growth stocks that might be reasonably priced or even undervalued, despite having a seemingly high P/E ratio, because their high growth rate justifies the premium. Conversely, it can highlight slow-growth companies that are expensive even with a modest P/E. It helps investors determine if they are paying a reasonable price for a company's future growth prospects.

What is a Good PEG Ratio?

A PEG ratio of 1 is generally considered to be fair value, suggesting that the market is valuing the company's growth appropriately. A PEG ratio below 1 often indicates that the stock may be undervalued relative to its earnings growth potential, making it potentially attractive to investors. Conversely, a PEG ratio above 1 might suggest that the stock is overvalued, as its price is high compared to its growth rate. It's important to note that what constitutes a 'good' PEG can vary by industry. High-growth sectors, like technology, might naturally have higher P/E ratios and thus potentially higher PEG ratios while still being considered reasonable, whereas mature industries might have lower PEG ratios.