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PEG Ratio

What is the PEG Ratio?

The PEG ratio, or price-earnings-to-growth ratio, is the ratio of a company’s price to earnings ratio (P/E ratio) to
the company’s forward projected earnings per share (EPS) growth rate.

While the P/E ratio essentially tells investors how much money people are willing to pay for a stock today based
on its past or future EPS, the PEG takes this a step further by putting the projected growth rate of the
company’s earnings in the denominator. The PEG ratio, compared to other market multiple ratios, is considered
a better indicator of a stock’s possible true value. Similarly, to the P/E ratio, a lower PEG ratio likely means that
the stock is undervalued, while a higher PEG means the stock is possibly overvalued.

Key Takeaways
The PEG ratio is an extension of the P/E ratio, and is another quick way for investors to determine the
value of a stock by accounting for projected earnings growth.
The PEG ratio takes into account a stock’s price, a stock’s earnings, AND a stock’s projected EPS
growth rate. Neither the P/B or P/S ratio consider a stock’s earnings or its forecasted growth.
A PEG ratio of 1 in theory represents a fair value and perfect correlation between a company’s stock price
and its projected earnings growth. PEG ratios over 1 are generally considered overvalued, and PEG ratios
between 0 and 1 may offer opportunities for higher returns.

PEG Ratio Formula

The PEG ratio is calculated using the following formula:

PEG Ratio = (P/E Ratio) / Forecasted EPS Growth

P/E Ratio = Current Price Per Share / Earnings Per Share

Current Price Per Share: The current price per share is the most recent price that a stock has traded at
and is not a fixed price. It is driven by market forces, and is consistently fluctuating throughout the trading
day. Earnings per share, or EPS, is the value of earnings per a company’s outstanding shares. It shows
how much money a company earns per share of their stock.

Forecasted EPS Growth: This refers to the forecasted growth of a company’s EPS in future periods.
This is always expressed as a percentage and is a rolling 12 month forecasted number based on the
estimates of analysts. It weights this current year and next year’s earnings forecasts depending on where
a company stands in its current fiscal year.
How to Calculate the PEG Ratio Using Financial Data
It is impossible to calculate a company’s PEG ratio exclusively from their income statement. That is because
we still need the company’s current price per share, as well as its forecasted EPS growth rate. However, when
computing a ratio such as the PEG ratio with so many moving parts, and different data from different sources,
the best way to do it is to find a reliable source you trust, and simply get the data from there. While a company’s
financial statements are crucial to analyze, these statements are only released quarterly. For the most up to
date data, it is often best to simply go off of what sources such as Yahoo! Finance are saying in order to
calculate ratios such as the PEG ratio.

Say we wanted to calculate the PEG ratio for a company that is considered high growth, such as Etsy (ETSY).
Etsy is an e-commerce platform for artists and creators, and has been one of the biggest winners during the
COVID-19 pandemic. According to Yahoo! Finance their P/E ratio (TTM) currently stands at 96.53.

This P/E ratio is relatively high and indicates that Etsy is currently trading at 96.53 times its earnings. This
means that investors are willing to pay 96.53 times what ETSY is earning per share. Many would consider this
overvalued. Others would say that this is the price you have to pay to invest in growth potential.

Additionally, According to Yahoo! Finance, based on analyst projections, Etsy’s 5 year EPS growth rate is
57.05%.

Now that we have both these ratios we can calculate the PEG ratio for ETSY:

PEG Ratio = 96.53 / 57.05 = 1.69

The PEG compares a company’s P/E to its growth rate, and tells a more comprehensive story than the P/E
ratio alone. A PEG ratio tells investors how much they are willing to pay per each unit of earnings growth. As
previously said, a PEG ratio of 1 indicates fair value, while a PEG ratio greater than 1 indicates possible
overvaluation.

While the PEG ratio which we’ve calculated here is a better indicator of ETSY trading at fair value it still
indicates a stock that is trading at a slightly overstretched valuation. Usually the stocks that offer the best
returns have a PEG between 0 and 1.

What is a Good PEG Ratio?

Deciding if a P/E ratio is “good” is or “bad” is largely subjective. However, PEG ratio is different. It’s relatively
clear cut, and more conclusive. It’s pretty simple really. A PEG ratio essentially tells investors how much they
are willing to pay per each unit of earnings growth. A PEG ratio in 1 in theory represents a fair value and perfect
correlation between a company’s stock price and its projected earnings growth. PEG ratios over 1 are generally
considered overvalued, and PEG ratios between 0 and 1 usually offer the best opportunities for higher returns.

A PEG Ratio is “bad” if it’s negative. A negative PEG shows that a stock has negative earnings or forecasted
negative earnings growth. Negative PEG ratios are also usually considered worthless or as an indicator of a
risky investment.

While PEG ratios can fluctuate between different sources for various reasons, it’s still always good to compare
ratios from company to company, and to the larger sector in which it operates. While the data we have for
ETSY’s PEG ratio may be more up to date than what is posted on finance sites, and comparing what we
calculated to other company’s PEG ratios may show an imbalance between real time data and trailing data, it’s
still good to take a look at the comparisons.

Stock/Index PEG Ratio

Etsy (ETSY) 1.69
Amazon (AMZN) 1.18
Ali Baba (BABA) 1.41
Walmart Inc. (WMT) 4.19
Ebay (EBAY) 0.86
Services Industry 2.02

One can interpret this a few ways. On one hand Etsy is trading in the middle of the pack compared to the
services industry, and compared to other e-commerce retailers. Walmart, while not exclusively e-commerce, is
building their e-commerce platform, and is trading with a PEG ratio that indicates overvaluation. A PEG ratio
over 1 is considered overvalued. A PEG ratio over 4 indicates a company where investors will pay 4 times more
then each unit of earnings growth – which is exceptionally high. On the other side, a company like Ebay, which
has a PEG ratio of .86, indicates a company that is undervalued, and a company that investors are not paying a
lot relative to each unit of earnings growth. Usually stocks between 0-1 have the most upside, and are
considered the most undervalued.

It’s always important however to judge a stock’s PEG ratio based on the broader sector it’s trading in. The
services industry, which is the broader sector that ETSY is trading in, has a PEG ratio of 2.02 based on data.
Etsy’s PEG ratio of 1.69 is lower than this, which means that although it is over 1, has more fair value than the
sector, and has more potential upside than the sector. But again- this is comparing ETSY’s most recent data to
data that may not be as up to date.

All of the following reasons might lead to some issues when interpreting the PEG ratio:

Inconsistent Data: As demonstrated in this report, PEG data can fluctuate between sources, and may
not necessarily be universal. The growth rate is largely based on speculation from different analysts. P/E
ratios may also not be uniform as quoted from different financial websites. This can cause challenges
when comparing companies as you may have more updated info for one company versus older info from
another.
Subjective Interpretation: Much like the P/E ratio, this is not a ratio based off of the actual balance
sheet of a company, nor is it based exclusively off their income statement or cash flow. In fact, it’s even
more subjective than the P/E ratio, because it’s based on the opinions of different analysts and what they
think a company’s growth prospects would be.
 Not as Useful When Evaluating Mature Companies: When evaluating mature companies that pay
dividends, rather than reinvesting profits into growth, the PEG ratio can be less uesful. The PEG ratio has
severe limitations when measuring companies with low growth. For example, if there is a mature
company that is forecasted to grow its earnings at 1% over the next 5 years, it will not have a PEG ratio
close to 1. However, it may pay significant dividends and be attractive to investors regardless.

Comparing PEG Ratios of Etsy (ETSY), Chevron (CVX), and

Marriott (MAR)
To see how to understand the PEG ratio in practice, consider the PEG of a growth stock like Etsy (ETSY), an
underperforming energy stock such as Chevron (CVX), and a struggling hotel company such as Marriott (MAR).

These companies are in very different industries, and are very different stocks. One is a stock with robust
growth, the other is a mature energy company with more of a focus on maintaining its dividend than investing in
growth, and the other is somewhere in between and has struggled due to COVID-19. This will illustrate the
differences in PEG ratios between considerably different companies, and expose some of the limitations of the
ratio.

Stock PEG Ratio

Etsy (ETSY) 1.69
Chevron Corporation (CVX) .64
Marriott International, Inc. (MAR) 4.23

How is this to be interpreted? It really does not tell us much. While Chevron has a PEG ratio of .64 indicating
that it is undervalued, and that investors are not paying a lot relative to each unit of earnings growth, Marriott’s
PEG is over 4 indicating the exact opposite. This is likely due to the low expected earnings growth over the next
few years due to COVID-19.

Etsy is in the middle between these two, despite the fact that it has a 5 year EPS growth estimate of 57.05%,
compared to Chevron’s negative 5 year EPS growth estimate of -3.73% and Marriott’s negative 5 year growth
estimate of -6.72%. This is why this ratio can be very ambiguous, inconsistent, and difficult to interpret.

PEG Ratio vs. Price to Book Ratio

The first ratio we can compare the PEG ratio to is the P/B ratio, or the Price-to-Book ratio.

The P/B ratio is calculated using the following formula:

P/B Ratio = Current Price Per Share / Book Value Per Share

Current Price Per Share: The most recent closing price for a stock.
Book Value Per Share: The Book Value Per Share takes a company’s common equity and divides it by
its number of shares outstanding. This value essentially indicates a company’s net asset value (total
 assets-total liabilities) on a per-share basis.

While the PEG ratio is preferred by growth investors, the P/B ratio is strongly preferred by conservative
investors. Additionally, while the PEG ratio is of minimal use when evaluating mature companies, the P/B ratio is
the opposite. The P/B ratio offers a more tangible valuation of a company than their earnings, however, it does
not work well with growth companies.

While the P/B ratio gives investors a better idea of the types of assets behind a certain stock, it does not work
well for asset light industries such as tech companies. The PEG ratio serves a different purpose than the P/B
ratio. While often both ratios are important to analyze together in order to take an accurate picture of a
company’s value and financial health, this is not always the case. It’s important to understand the type of
company that is being researched when using each of these ratios.

PEG Ratio vs. P/S Ratio

The next ratio we can compare the PEG ratio to is the P/S ratio, or the Price-to-Sales ratio.

The general formula for the P/S ratio is as follows:

P/S Ratio = Current Price Per Share / Sales Per Share

Current Price Per Share: Most recent closing price for a stock.
Sales Per Share: The amount of revenue a company makes per share. It’s calculated by dividing a
company’s revenue by the total number of shares outstanding. Revenue and shares outstanding have to
be from the same period when calculating this ratio – either quarterly or annually.

While the P/S ratio is advantageous in that you can still calculate it even if companies are not profitable and
operating at a loss, this ratio is more easily manipulated and misleading. Simply put, this is not a
comprehensive ratio. Depending on how profitable a company truly is, their sales could be worth a little or a lot.
For example, a company could be making billions in sales, yet lose money on every transaction – but the P/S
ratio would give you minimal insight in this situation.

To summarize:

Metric Pros Cons

PEG Ratio An extension of the P/E ratio. May not be universal between
Simple snapshot of a company’s sources. The growth rate is largely
(P/E valuation, and more speculative, and P/E ratios may not be
Ratio)/Forecasted
comprehensive because it takes uniform between past, current, and
EPS Growth into account growth. future metrics.
 Better metric than other market Not as useful when evaluating
multiple ratios to find a company’s dividend paying companies such as
true value utilities with little forecasted growth.

Useless when evaluating growth

Best ratio for conservative companies with little assets such as
P/B Ratio investors – offers a more tangible tech companies.
valuation of a company than their
Current Price Per Can be especially difficult when
earnings.
Share/Book Value Per comparing or evaluating companies
Share Gives investors a clearer picture of that adhere to different accounting
the types of assets behind stocks. standards- ie. international
companies.

Quick and easy snapshot in Largely ignores company profitability.

P/S Ratio
comparing companies within the Is not comprehensive enough to be an
Current Price Per same industry. acceptable standalone ratio.
Share/Sales Per
Can still calculate it even if a Does not explain the true worth of a
Share
company is not profitable company’s sales.

Drawbacks to Market Multiple Ratios

While market multiple ratios are a good way to take a snapshot of a company’s valuation, there are several
serious flaws and drawbacks to consider before putting too much stock and emphasis into these ratios.

Difficult to Compare Companies in Different Sectors: Like any other ratio, market multiple ratios are
only truly effective and comprehensive when comparing companies within the same industry. Different
companies in different industries have different growth prospects, different balance sheets, different
income statements, and different revenue streams. How can we compare the Price to Book ratio
between JP Morgan and Salesforce for example, when JP Morgan has countless assets and Salesforce
doesn’t? What is the point in comparing JP Morgan and Salesforce’s Price to Sales ratio, for example,
when one company makes their money off of interest payments and the other company makes their
money off of enterprise technology services? These ratios only tell part of the story and must be used in
conjunction with other metrics to truly evaluate a given stock.
Overly Simplifies Complex Information: While making these ratios so simple can be advantageous in
that it gives investors a quick snapshot into a company’s value, the oversimplification has serious
drawbacks as well. By simplifying complex information into just a single ratio, other factors that can
influence a company’s performance are effectively ignored and disregarded.
Only Accounts for Past Data: While the Forward P/E ratio is based off of future projections, they are not
always reliable or trustworthy. For the most part, these market multiple ratios only consider a company’s
finances from the past and at a certain point in time, and neglect to include a company’s growth
prospects or future business operations.
Not Adjusted for Different Accounting Practices: Ratios such as the P/B ratio are not good when
comparing companies with different accounting practices- namely international companies. Even if a
company like Salesforce and SAP have similar business operations, they may have vastly different
accounting policies. After all, one company is American, and the other is German. The multiples may be
easily misinterpreted as a result, with inconclusive comparisons.