Work out the PEG (P/E-to-growth) ratio, explain what it means and how it is used in relative valuation
The idea
The PEG ratio divides the P/E by the expected earnings growth rate expressed in percentage points, so a P/E of 20 with 10% growth gives a PEG of 2. It adjusts the P/E for growth, letting the analyst compare companies with different growth prospects: a lower PEG suggests a more attractive valuation relative to growth. Its drawbacks are that it assumes a straight-line relation between P/E and growth, it ignores how long the growth will last, since one number is used whether growth lasts two years or ten, and it ignores differences in risk, which also drive the P/E. The trap is comparing PEGs across companies with very different risk or growth horizons, or entering growth as a decimal rather than a percentage.
In the app: 1 practice questions on this outcome, a narrated walkthrough with diagrams, spaced review that brings it back before you forget it.
Take the free diagnostic →More in Market-Based Valuation: Price and Enterprise Value Multiples
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