PEG Ratio

The PEG ratio divides the price-to-earnings ratio by the earnings growth rate. A stock at a P/E of 20 growing earnings 20% a year has a PEG of 1. It tries to express, in a single number, whether today's price is expensive once growth is taken into account.

Its purpose comes from a weakness in P/E alone. A company at 30 times earnings looks expensive next to one at 10 times, but if the first grows 40% a year and the second is flat, the picture changes. Fast earnings growth means a far lower P/E a few years out, and PEG folds that future into the number.

The usual reading is that a PEG near 1 is a price in line with growth, and below 1 suggests the stock is cheap relative to how fast it is growing. Treat that as a rough guide rather than a rule. Different industries earn different multiples, and steady growth deserves more credit than erratic growth.

Its biggest weakness is the denominator. The growth rate changes dramatically depending on whether you use past results or forward estimates, and estimates are only forecasts. Optimistic analyst projections can make almost any PEG look attractive. So rather than using it alone, check what the growth number is based on and weigh the risk that growth, not just earnings, could stall.