Module II· Multiples & Sector SpecificsIntermediate
Question
What is the PEG ratio and when is it useful?
Answer
Mechanics
The PEG ratio is the P/E ratio divided by the earnings growth rate (in %):
```
PEG = P/E / EPS growth (%)
```
Rule of thumb
PEG around 1.0 = fairly valued; <1.0 = cheap; >1.0 = expensive.
Deep diveShow more details
Example 1 (cheap)
Inputs:
- P/E: 20x
- EPS growth: 25%
Calculation:
```
PEG = 20 / 25 = 0.8 (cheap)
```
Example 2 (expensive)
Inputs:
- P/E: 30x
- EPS growth: 15%
Calculation:
```
PEG = 30 / 15 = 2.0 (expensive)
```
Application
comparing growth companies with different growth rates.
Weaknesses
- The growth-rate estimate is volatile (5Y forward, FY+1, etc.).
- It ignores risk (beta, capital intensity).
- It ignores the quality of growth (organic vs. M&A).
For quality growth compounders, a PEG below 1 is often read as an 'underpriced quality' signal.
Pitch tip
PEG is more an equity-research tool than an IB tool — use it in a pitch as a sanity check, not as the primary valuation method.