The Price/Earnings to Growth ratio, or PEG ratio, is a valuation metric used to determine a stock’s potential value while taking into account its earnings growth. The calculation involves dividing a stock’s price-to-earnings (P/E) ratio by the company’s earnings growth rate over a specified period. For example, if a company has a P/E ratio of 20 and an expected earnings growth rate of 10%, the result of dividing 20 by 10 would result in a PEG ratio of 2.0.
This ratio is considered useful because it expands on the P/E ratio by factoring in anticipated growth. A lower ratio may suggest that a stock is undervalued, given its expected earnings expansion. Conversely, a higher ratio could indicate overvaluation. While its origins are somewhat debated, its widespread adoption reflects the market’s need for a more refined approach to evaluating investment opportunities.