Angel Investors Network
    Glossary

    Price to Earnings Growth

    Price to Earnings Growth (PEG) is a valuation metric that divides a company's P/E ratio by its expected earnings growth rate. It helps investors determine whether a stock is overvalued or undervalued relative to its growth prospects. A PEG below 1.0 typically suggests the stock is undervalued compared to its growth potential, making it more attractive for value-conscious investors.

    Price to Earnings Growth (PEG) is a valuation metric that compares a company's P/E ratio to its expected earnings growth rate. Calculated by dividing the P/E ratio by the annual earnings growth rate (as a percentage), PEG provides a more complete picture than the P/E ratio alone. It answers a critical question for investors: are you paying a fair price for the company's future growth?

    How It Works

    The formula is straightforward: PEG = P/E Ratio ÷ Earnings Growth Rate. For example, if a company has a P/E of 30 and expected earnings growth of 20% annually, the PEG would be 1.5 (30 ÷ 20). The resulting number tells you how many years of growth you're paying for with each dollar of current earnings. A PEG of 1.0 is often considered fair value—you're paying one year's worth of growth for the stock. A PEG below 1.0 suggests undervaluation, while above 2.0 typically signals overvaluation.

    Why It Matters for Investors

    The P/E ratio alone can be misleading. A company with a high P/E might be a terrible investment if growth is slow, or an excellent opportunity if growth is explosive. PEG corrects this blind spot by contextualizing the valuation against growth expectations. This is particularly valuable for growth-focused investors and angel investors evaluating high-potential companies. It helps you distinguish between expensive stocks that justify their premium and overpriced ones riding hype.

    Example

    Compare two software companies: Company A trades at a P/E of 40 with 35% projected growth, yielding a PEG of 1.14. Company B has a P/E of 25 with only 10% projected growth, giving a PEG of 2.5. Despite the lower absolute P/E, Company B is actually more expensive relative to its growth prospects. An investor focused on growth would find Company A more attractive.

    Key Takeaways

    • PEG adjusts the P/E ratio for expected earnings growth, providing better context for valuation decisions
    • A PEG below 1.0 generally signals undervaluation; above 2.0 suggests overvaluation
    • Use PEG alongside other metrics like revenue growth and DCF analysis for comprehensive due diligence
    • PEG relies on growth projections, which can be unreliable; always verify assumptions with company guidance and market research