Including: What is considered a good PEG ratio?
What is the price/earnings-to-growth (PEG) ratio?
The price/earnings-to-growth ratio, commonly called the PEG ratio, measures the value of a company’s shares over a given period of time.
Express differently, the PEG ratio is a calculation that determines the value of the shares of a company based on the company’s current earnings and the potential future growth of the company.
The PEG ratio is considered an improved version of the price-to-earnings (P/E) ratio because it adjusts the P/E ratio by also factoring in the expected growth of a company’s earnings.
In addition, the PEG ratio provides a more comprehensive picture than the traditional and more standard price-to-earnings (P/E) ratio.
Both the PEG ratio and the P/E ratio are accounting ratios, also known as financial ratios, which are used to evaluate, inter alia, the liquidity, profitability, debt coverage, and market value of a company.
Furthermore, the two ratios are categorised as market value ratios, also called market-related ratios, which measure the current share (stock) price of a publicly-traded company, determining whether the company’s shares are overvalued, undervalued, or reasonably priced.
Components of the PEG ratio
The following components are needed to calculate a company’s PEG ratio:
- The share (stock) price.
- Earnings per share (EPS).
- Earnings per share (EPS) growth rate.
The share price and the earnings per share are required to calculate the price-to-earnings (P/E) ratio of the company.
The EPS growth rate can be the actual or the projected rate of growth.
Calculating the P/E ratio
The formula to determine the P/E ratio is:
P/E ratio = Company’s share price/Earnings per share (EPS)
Where:
- A company’s share price refers to its current share price, obtained from a stock exchange where the shares are traded.
- Earnings per share (EPS) is calculated by dividing a company’s net profit by the number of its outstanding ordinary shares, which are the ordinary shares currently held by shareholders, institutional investors, and company insiders.
Example of the P/E ratio:
The current share price of the company Prosperous is R75 per share.
The company reported a net profit of R2.5 million and it has 250 000 ordinary shares outstanding, which reflect earnings per share (EPS) of R10 (ten ZAR) (R2 500 000/250 000).
PE/ratio = R75/R10
= 7.50
The result of 7.50 shows how much shareholders are prepared to pay for one rand (ZAR) of a company’s profit/earnings.
The P/E ratio is also known by the following names: the price-earnings ratio, price multiple, or earnings multiple.
Determining the earnings per share (EPS) growth rate
The earnings per share (EPS) growth rate is used as the denominator in the formula to calculate a company’s PEG ratio.
EPS growth indicates the growth of the earnings per share over a given period of time, such as a quarter or a financial year, enabling shareholders/investors to identify company shares that are increasing or decreasing in profitability.
As already mentioned, the EPS growth rate can be the actual or the projected growth rate.
- Actual growth rates are based on historical growth rates. For example, a company reported an EPS of R4.50 in 2025 and an EPS of R6.00 in 2025. The company has an EPS growth rate of 33.33% (((R 6.00/R4.50) – 1) x 100) during the financial year 2025.
- A projected growth rate, also called expected growth rate or future growth rate, is an estimate, which is an approximate calculation of what the future EPS growth rate of a company will be.
It is important to determine which growth rate was used in the PEG ratio calculation. Different calculations can lead to totally different answers, making it difficult for investors to accurately evaluate the value of a company’s shares.
For instance, actual growth rates may provide an incorrect (even a false) PEG ratio if projected growth rates are expected to contradict a company’s historical growth rates. There may be valid reasons to assume that future growth will slow or gain momentum.
The difference between using the historical growth rate or future growth rate to calculate the PEG ratio is referred to as ‘trailing PEG’ and ‘forward PEG’ respectively.
How to calculate the PEG ratio
The formula to calculate the PEG ratio for a company is as follows:
PEG ratio = PE ratio/EPS growth rate
Where EPS growth rate is also referred to as annual earnings per share growth rate, EPS growth, expected rate of growth, or EPS growth rate.
Examples of PEG ratios:
Example #1 (PEG calculation based on future growth rate)
Company A is expected to have an annual growth rate of 9% over the next three years. The company’s current share price is R70, and its EPS is R8.00.
To calculate the PEG ratio, firstly, the price-to-earnings (P/E) ratio has to be determined.
PE ratio = Current share price/EPS
= R70/R8
= 8.75
Generally, a PE ratio of less than 1 is an indication that a company’s shares may be undervalued, while a ratio of greater than 1 indicates that they may be overvalued. Hence, company A’s shares may be considered overvalued.
To enable investors to have a better look at the value of company A’s shares, its PEG ratio is calculated, based on its expected future growth.
PEG ratio = R8.75/9%
= 0.97
The PEG ratio of 0.97 indicates that the shares of company A are considered undervalued when the future growth rate of earnings is taken into account.
Example #2 (PEG calculation based on historical growth rates)
- The current share price of company B1 is R56.
The company reported EPS of R3.10 for the 2025 financial year and EPS of R2.75 for the 2019 financial year.
The company’s PEG ratio is calculated as follows:
P/E ratio = R56/R3.10
= 18.06
Earnings growth rate based on historical figures = (R3.10/R2.75) – 1
= 0.13
Expressed as a percentage = 13% (0.13 x 100)
PEG ratio = 18.06/13
= 1.39
- The share price of company B2 currently trades at R75.
Its EPS for the current financial year is R2.44 and for the previous financial year R1.58.
Company B2’s PEG ratio is determined as follows:
P/E ratio = R75/R2.44
= 30.74
Earnings growth rate based on actual figures = (R2.44/R1.58) – 1
= 0.54
Expressed as a percentage = 54% (0.54 x 100)
PEG ratio = 30.74/54
= 0.57
Comparing the ratios of company B1 with those of company B2, the following specifics can be observed:
- PE ratios
With a PE ratio of 18.06, the shares of company B1 are cheaper than the shares of Company B2 with a PE ratio of 30.74.
- PEG ratio
When observing the PEG ratios of the two companies, it seems that company B2’s expected growth rate of 54% provides a PEG ratio of 0.57, while company B1’s expected growth rate of 13% provides a PEG ratio of 1.39.
This means that buying the shares of company B2, is a more valuable option in the long term than acquiring the shares of company B1.
What is a good PEG ratio?
The PEG ratio of a company provides a better analysis of whether its shares are undervalued or overvalued.
Keep in mind, the earnings and growth potential of companies vary considerably among industries, making it difficult to mention a standard figure that indicates an undervalued or overvalued stock.
That said, in general, a PEG ratio may suggest the following about the value of a company’s shares:
- A PEG ratio of one is an indication that the market’s perceived value of a company’s shares corresponds with what investors can expect of the future growth of the company’s earnings/profit.
- A PEG ratio of less than one suggests that a stock is undervalued, implying that either the expected growth rate is too low or that the stock market has misjudged the stock’s growth potential and value.
- A PEG ratio of more than one usually signals that the market anticipates more growth than fundamental estimations suggest. It can also be an indication that the increased demand for a company’s stock has caused it to be too expensive.
However, a PEG ratio of less than or higher than 1.0 does not necessarily mean a company’s stock is a bad or good investment.
Share prices are typically influenced by demand, speculation, and expectations of investors – many times unfounded. An absolutely valueless company could have a high share price because emotional investors (driven by fear or greed) keep pushing the price up.
Therefore, the PEG ratio should be used as just one of many methods to evaluate a company’s shares.
This article does not intend to provide investment or trading advice. Its aim is only informative.
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