Term · Valuation
PEG Ratio
In briefThe PEG ratio divides the price-earnings ratio by the expected earnings growth rate in percent. It is meant to show whether a high P/E is justified by growth; a value around one is seen as a rough balance. Because it relies on estimates, it is highly assumption-dependent.
Definition
The PEG ratio relates the price-earnings ratio to the expected earnings growth rate. It is meant to assess whether a P/E is high or low in light of expected growth. A value around one is used as a rough guide that valuation and growth are broadly in line.
How it is calculated
Formula. PEG = P/E ratio ÷ expected annual earnings growth rate (in %)
Why it matters for small caps
For fast-growing small caps, the PEG ratio puts an optically high P/E into perspective. However, it depends heavily on uncertain growth estimates, which can be especially volatile for small companies.
Common misreadings
- The PEG ratio is often treated as a precise metric, even though it is based on estimated future growth and even small errors in the assumptions strongly change the result.
In the process
Frequently asked
What does a PEG of about one mean?
Roughly interpreted, it suggests that the P/E is approximately in line with the expected growth rate. It is a guideline, not a fixed valuation threshold.
Where do the weaknesses of the PEG ratio lie?
It depends entirely on the estimated growth rate. This is uncertain, especially for small companies, and different periods or assumptions lead to very different values.
Which growth rate is used?
An expected medium-term earnings growth rate is common. Because there is no fixed convention, the underlying assumptions should always be disclosed and reviewed.
Related terms
Education only, not investment advice. Ranges and thresholds are didactic orientation values, not an official standard.