PEG Ratio

The PEG ratio divides a stock's P/E by its expected earnings growth rate, scaling the multiple to the growth that is supposed to justify it. A stock at a P/E of 30 growing earnings 25% a year has a PEG of 30 / 25 = 1.2.

The rule of thumb popularized by Peter Lynch: a PEG near 1.0 means you are paying roughly one turn of P/E per point of growth; well below 1.0 suggests growth is going cheap, well above 2.0 suggests you are paying up. The catch is the G — it is a forecast, usually the analyst consensus for the next 3-5 years, and forecasts miss.

PEG breaks at the extremes. It punishes slow growers unfairly (a utility at 12x with 3% growth shows a PEG of 4.0 despite being cheap on other measures) and says nothing about companies with negative or erratic earnings.