Introduction
The PEG Ratio (Price/Earnings to Growth) was popularized by Peter Lynch. Adjusts the P/E Ratio by the profit growth rate, allowing you to compare high-growth vs. mature companies.
Explanation
A P/E of 40 seems expensive, but if the company grows profits 40% annually, it may be reasonable. The PEG captures this. Peter Lynch looked for companies with PEG < 1 ("fairly priced growth").
Formula
PEG Ratio = P/E Ratio / Earnings Growth Rate (%)
Example: P/E 30, Growth 30% → PEG = 1.0
Example
Amazon (2015) vs Bank of America: - Amazon: P/E 100, Growth 40% → PEG = 2.5 - BofA: P/E 12, Growth 5% → PEG = 2.4 Amazon looked very expensive on a P/E basis, but its PEG was similar to a mature bank.
How to read it
PEG < 1.0 = underrated (Lynch loved him). PEG 1.0-1.5 = fair valuation. PEG > 2.0 = expensive. PEG works best for stable growth companies. Does not work well for: cyclical companies, companies with erratic growth, loss-making companies. Red flag: PEG >3 = market pays too much for growth.
Key takeaways
- PEG = P/E / Growth Rate
- Peter Lynch: look for PEG < 1.0
- PEG < 1.0 = undervalued
- PEG > 2.0 = expensive
- Does not work for cyclical or non-profit companies
- Amazon 2015: P/E 100 but reasonable PEG