Conventional wisdom says that a good PEG ratio is anything below 1. But actually, there’s a lot that can go wrong with that assumption!
The PEG ratio is a shortcut for determining how cheap a stock is relative to its growth. The lower the PEG, the cheaper a stock is trading (relative to its earnings and growth in earnings).
Figuring out that growth part can be tricky though.
Finding a good, realistic estimate for growth makes conventional wisdom about what a good PEG ratio is a bit murky.
We will cover the basics of the PEG and simple pitfalls to keep in mind when determining what you define as a “good” PEG ratio.
The Basics of the PEG Formula
The PEG ratio was one popularized by the famed fund manager Peter Lynch, who went on to post one of the best mutual fund track records of all time.
Lynch used the PEG to identify good growth stocks trading at reasonable prices.
The formula for the PEG ratio is:
PEG = Price to Earnings / Growth
Where Price to Earnings = Price / Earnings.
Generally, any PEG below 1 is considered very good. This means you’re getting a discount on the company compared to its growth rate. You can think of a PEG of 1 as fair value. There’s no discount, but no premium (in price paid) for the growth of that stock.
A PEG around 1.5 is where a stock can start to be considered more expensive, and generally one above 2 is considered expensive.
How to Calculate the PEG Ratio Example: $AAPL
Let’s take a look at Apple’s ($AAPL) latest financials, and I’ll show you how to use that information to estimate its PEG ratio.
Remember that to calculate the PEG, we’ll need:
- The P/E ratio
- Earnings Growth
To keep things apples-to-apples, we’ll use “per share” values. In other words, we’ll calculate the P/E using Earnings Per Share and the earnings growth by the same Earnings Per Share.
First, I’ll check our handy Google friend to see where Apple ($AAPL) is trading at today.
- Share price= $157.78
Easy enough, we have the “Price” part of the P/E. Next we’ll pull up the company’s EPS (TTM, or Trailing Twelve Months), which you can find in the Financials tab of a great free website for stock market KPIs called Stratosphere.io.
With those numbers in hand, we can calculate the company’s P/E ratio today:
- Price = $157.78
- EPS = $6.05
- P/E = 157.78 / 6.05
- P/E = 26.1
Next, we need to calculate the (G) of PEG, the growth. The simplest way would be to look at the company’s YOY (year over year) growth in EPS.
Moving to the financial Statements tab, we can make that calculation as follows:
- 2021 EPS = $5.61
- 2020 EPS = $3.28
- EPS YOY = (5.61 / 3.28) – 1
- EPS YOY = 71.0%
Finally, plug the two inputs, our P/E and EPS Growth, into the PEG formula as so:
- PEG = (P/E) / Growth
- PEG = 26.1/ 71.0
- PEG = 0.37
Is this a good PEG ratio for Apple?
Realistically, the huge growth rate in EPS from 2020 to 2021 should not be expected to be the norm for a company over the long term. Better yet would be to make an adjustment to find a more reasonable growth rate.
Making Better Growth Estimates
A more accurate way to calculate the PEG ratio for a company is by averaging multiple years of growth instead of using just one YOY value.
This is because earnings (and EPS) can fluctuate wildly from year-to-year, which isn’t necessarily a bad thing. It’s just the nature of businesses.
For example, say Apple just released a brand new iPhone that was a blockbuster hit. Say the next year the company had no new phone releases; that next year after the blockbuster would show little growth. Some business models see this kind of phenomenon more than others.
Going back to our example one more time, let’s take the average of 3 YOY growth rates for Apple:
- 2021 EPS = $5.61
- 2020 EPS = $3.28
- EPS YOY= 71.0%
- 2020 EPS = $3.28
- 2019 EPS = $2.97
- EPS YOY= 10.4%
- 2019 EPS = $2.97
- 2018 EPS = $2.98
- EPS YOY = -0.3%
- 3-year avg growth = 27.0%
Is this a better growth estimate?
Maybe… it’s still very high but at least is averaged out over several years to account for fluctuations from year to year. The updated PEG for Apple in this case would be 0.97 rather than 0.37.
Potential Pitfalls of the PEG Ratio
One pitfall which I don’t see talked about at all, is that higher growth rates are actually pretty rare in the stock market.
To prove this to you, I went back through 20 years of financial data for S&P 500 constituents and looked at their YOY growth in EPS.
Then I took the MEDIAN of these YOY growth numbers (this is better than taking an average because it weeds out the extremes, high and low).
Here’s what I found:
- 52% of companies had a median YOY EPS Growth of 5%+
- 30% of companies had a median YOY EPS Growth of 10%+
- 13% of companies had a median YOY EPS Growth of 15%+
- 5% of companies had a median YOY EPS Growth of 20%+
- 2% of companies had a median YOY EPS Growth of 25%+
- 1% of companies had a median YOY EPS Growth of 30%+
In other words, you have a 50-50 shot of picking a company with consistent EPS growth of only 5% or greater. That’s not very good.
Consider that the number of stocks that trade at a P/E ratio of around 5 is pretty slim, and so you have a 50-50 chance of being wrong in thinking you have a good (accurate) PEG ratio if your PEG is under 1 and yet you’re paying more than a 5x P/E.
On the other end of the spectrum, it’s incredible to me that only 2% of the S&P 500 companies had a median EPS growth rate of 25%+.
This means that if you think you have a good PEG ratio because your company’s P/E is 25 and their growth is 25, you’re probably wrong. Actually, only 2% of companies have been able to sustain that!
What looks to be more realistic, based on these probabilities, are growth rate estimates somewhere between 5%-10%.
And using what we know about the stock market, over the very long term the P/E ratio has been around 15-17. And so, it might be more realistic to say that you’ll probably have to pay a PEG of around 1.5- 3.0, at least if you’re being honest about the company’s true long term growth.
More Evidence About the Pitfalls of the PEG Ratio
Famed investment strategist Michael Mauboussin wrote a fantastic report called “The Base Rate Book.” It included groundbreaking research on historical growth rates.
I wrote an entire blog post to try and summarize his findings. I highly recommend reading both the post and his book to really internalize the lessons.
But basically, it came down to the fact that for most companies, their past growth did NOT prove to be a great indicator for future growth.
After sifting through 65 years of data, Mauboussin found that there was more luck involved (“reversion to the mean”) than skill when it came to future revenue growth rates. This has profound implications on EPS growth rates, since EPS growth follows revenue growth over the long term.
This has profound implications on our PEG ratio as well.
For example, say I’m looking at a stock that’s had 20% EPS growth over the long term. Maybe I doubt that the company can really maintain that kind of a growth rate to stay in the top 5% of S&P 500 companies historically.
Maybe it makes more sense to input 15% growth for the PEG ratio, even though the company did earn 20% growth. It’s clear that the odds are against them continuing such a fantastic streak.
In that way, we’ll have a more realistic estimate for growth, and thus a better calculation for our PEG ratio and if it really indicates a potentially undervalued stock or not.
I hope that all of this data wasn’t discouraging and didn’t feel like a firehose of information. If it did, take it slow and read through some of our other great resources on the PEG ratio, and those I’ve previously linked in this article.
The point I am trying to make is that metrics like the PEG are only as good as our understanding of them.
And one of the mistakes that I made when I was starting out was to take some of these ratios too literally, without providing thought into what they are truly indicating.
Numbers in the stock market are a great guide, but if we don’t understand them, we’ll be blind to times when they lead us astray.
Defining a good PEG ratio is one of those times.
Because growth is a primary input in the formula, you have to be careful about how you are calculating it. Especially with all of the variants out there on the internet today.
Hopefully this information better directs the performance of the stocks you choose to buy, based on how you project their future growth.
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In general, a good PEG ratio has a value lower than 1.0. PEG ratios greater than 1.0 are generally considered unfavorable, suggesting a stock is overvalued.What is a good 5 year PEG ratio? ›
A ratio between 0.5 and less than 1 is considered good, meaning the stock may be undervalued given its growth profile. A ratio less than 0.5 is considered to be excellent.What does a PEG ratio of 2 mean? ›
The math behind the PEG ratio is straightforward. One simply divides a company's P/E ratio by its expected rate of growth. A company with a P/E ratio of 20 and an expected growth rate of 10%, for example, would have a PEG ratio of 2 (20 / 10).Is a low or high PEG good? ›
PEG ratios higher than 1.0 are generally considered unfavorable, suggesting a stock is overvalued. Conversely, ratios lower than 1.0 are considered better, indicating a stock is undervalued.What is Walmart's PEG ratio? ›
Walmart's latest twelve months peg ratio is 0.68. Walmart's peg ratio for fiscal years ending January 2018 to 2022 averaged -0.54. Walmart's operated at median peg ratio of -0.82 from fiscal years ending January 2018 to 2022. Looking back at the last five years, Walmart's peg ratio peaked in July 2022 at 0.68.What is the PEG ratio of the S&P 500? ›
Example of a PEG Ratio.
|Biotech Stock ABC||Oil Stock XYZ|
|PEG||35/25, or 1.40||16/15, or 1.07|
The trailing PE ratio is 57.52 and the forward PE ratio is 35.97. Tesla's PEG ratio is 1.60. PE Ratio. 57.52. Forward PE.
Coca-Cola's latest twelve months peg ratio is 2.10.What is a low PEG? ›
PEG is a widely employed indicator of a stock's possible true value. Similar to PE ratios, a lower PEG means that the stock is undervalued more. It is favored by many over the price/earnings ratio because it also accounts for growth.How do you analyze PEG ratio? ›
Calculate the P/E by taking a stock's current share price and dividing it by its earnings per share (EPS). Calculate the PEG ratio by dividing the P/E ratio by the projected or actual earnings growth.
To get the PEG, you first divide a stock's price by its earnings per share (EPS), just as you would to get the P/E ratio. Once you have the P/E ratio, you divide that by the expected earnings-per-share growth rate over a period of time, often five years. If it's multiple years, you use the compound annual growth rate.Which stocks are undervalued now? ›
|1.||Forbes & Co||660.20|
The price/earnings to growth ratio (PEG ratio) is a stock's price/earnings ratio (P/E ratio) divided by its percentage growth rate. The resulting number expresses how expensive a stock's price is relative to its earnings performance.What is Amazon's PEG? ›
About PEG Ratio (TTM)
Currently, Amazon.com, Inc. has a PEG ratio of 2.59 compared to the Internet - Commerce industry's PEG ratio of 1.09.
Starbucks is currently a Zacks Rank #3 (Hold). In terms of valuation, Starbucks is currently trading at a Forward P/E ratio of 26.36. For comparison, its industry has an average Forward P/E of 20.89, which means Starbucks is trading at a premium to the group. Also, we should mention that SBUX has a PEG ratio of 2.02.What is Lowes PEG ratio? ›
The trailing PE ratio is 14.76 and the forward PE ratio is 13.05. LOW's PEG ratio is 0.93. PE Ratio. 14.76.
The sales per share metric is calculated by dividing a company's 12-month sales by the number of outstanding shares. A low P/S ratio in comparison to peers could suggest some undervaluation. A high P/S ratio would suggest overvaluation.What is the PEG ratio for Procter and Gamble? ›
For comparison, its industry has an average Forward P/E of 20.96, which means Procter & Gamble is trading at a no noticeable deviation to the group. It is also worth noting that PG currently has a PEG ratio of 3.2.What is the PEG ratio of the Nasdaq? ›
|Forecast 12 Month Forward PEG Ratio||5.29|
34 One of the reasons Amazon's P/E is so much higher than Apple's is that its efforts to expand aggressively on a wide scale have helped keep earnings somewhat suppressed and the P/E ratio high. The P/E ratio should be used with a variety of other analysis tools to analyze a stock.
The price to earnings ratio is calculated by taking the latest closing price and dividing it by the most recent earnings per share (EPS) number. The PE ratio is a simple way to assess whether a stock is over or under valued and is the most widely used valuation measure. Apple PE ratio as of November 11, 2022 is 24.50.What happens if PEG is high? ›
A PEG ratio above 1.0 suggests a stock is overvalued. In other words, investors who rely on the PEG ratio look for stocks that have a P/E ratio equal to or less than the company's expected growth rate. Of course, investors shouldn't rely exclusively on the PEG ratio or any other single financial metric.What is the difference between PE and PEG? ›
The price-to-earnings (PE) ratio and price-to-earnings growth (PEG) ratio are very similar. Both ratios are used to understand the company's stock price relative to its earnings-per-share (EPS). The only difference between the two ratios is that the PEG ratio factors in the expected growth rate on earnings.What is PEG and its significance? ›
Polyethylene glycol (PEG) is a polymer derived from ethylene oxide is an advantageous component for obtaining solid dispersions due to their physicochemical properties.What do PEG numbers mean? ›
The numbers that are often included in the names of PEGs indicate their average molecular weights, e.g. a PEG with n=9 would have an average molecular weight of approximately 400 daltons and would be labeled PEG 400. Most PEGs include molecules with a distribution of molecular weights; i.e. they are polydisperse.What is Nike's PEG ratio? ›
NIKE's latest twelve months peg ratio is -3.87. NIKE's peg ratio for fiscal years ending May 2018 to 2022 averaged 0.57. NIKE's operated at median peg ratio of 0.21 from fiscal years ending May 2018 to 2022. Looking back at the last five years, NIKE's peg ratio peaked in May 2020 at 6.40.Which is better PE or PEG ratio? ›
The P/E ratio is popular and easy to calculate, but it has shortcomings that investors should consider when using it to determine a stock's valuation. Since the P/E ratio does not factor in future earnings growth, the PEG ratio provides more insight into a stock's valuation.What is the PEG of Amazon? ›
Amazon.com's latest twelve months peg ratio is -1.73.Do low PEG stocks outperform? ›
The maths would suggest that, in general, the answer is yes. Estrada's study shows that low PEGR portfolios outperform both low PE and low PEG portfolios on a risk adjusted basis, suggesting that it may well be the true king of the value factors.How do you determine if a stock is undervalued or overvalued? ›
Price-book ratio (P/B)
To calculate it, divide the market price per share by the book value per share. A stock could be overvalued if the P/B ratio is higher than 1.