The PEG ratio helps in stock valuation by comparing a company's price-to-earnings (P/E) ratio with its earnings growth rate. It gives a clearer picture of whether a stock is overvalued or undervalued. A PEG ratio below 1 usually means the stock is undervalued considering its growth, while a PEG above 1 might suggest overvaluation. It helps investors make smarter decisions by factoring in growth.

What Is PEG Ratio in Stock Valuation?

PEG ratio stands for Price/Earnings to Growth ratio. It is calculated by dividing the P/E ratio of a stock by its annual earnings growth rate. This ratio helps investors know whether a stock’s price is justified by its future growth. It adds a layer of clarity over just looking at the P/E ratio alone.

How Is PEG Ratio Calculated?

PEG ratio is calculated using this simple formula: PEG = (P/E Ratio) ÷ (Earnings Growth Rate). For example, if a company has a P/E of 20 and an expected growth rate of 10%, the PEG ratio would be 2. This means you're paying 2 times more than the company’s earnings growth, which may not be attractive.

Why Is PEG Ratio Better Than P/E Ratio?

P/E ratio only shows the price you pay for current earnings. But PEG ratio adds the company’s growth rate to the equation. A stock may look expensive with a high P/E, but if it has strong earnings growth, the PEG ratio may still show it as undervalued. That’s why PEG is a better tool for long-term investors.

What Is a Good PEG Ratio?

A PEG ratio of 1 is considered fair value. It means the stock price is equal to its earnings growth. If the PEG ratio is below 1, the stock may be undervalued and could offer a good buying opportunity. If it’s above 1, the stock might be overvalued based on its growth.

Can PEG Ratio Be Used for All Stocks?

PEG ratio works best for growth stocks where earnings are expected to rise. It may not be useful for companies with unpredictable or slow growth, like some utility or banking stocks. Also, the growth rate is based on estimates, so if the forecast is wrong, the PEG ratio may not give the correct value.

How Can Investors Use PEG Ratio for Smart Decisions?

Investors can use the PEG ratio to compare different stocks in the same sector. It helps find companies that are growing faster but still available at a lower price. Always use PEG along with other tools like P/E, ROE, and debt levels to get a full picture of the stock's value before investing.