The PEG ratio is used to validate the value of a stock while taking into account the expected growth of the company. It is a variant of the P/E ratio. The ratio is particularly popular among investors with a longer investment horizon.

Calculating the PEG ratio

The calculation is fairly simple and consists of 3 components:

  • price per share
  • earnings per share, also known as EPS
  • expected EPS growth for the upcoming period, use a minimum of 1 year

With these 3 components we can create the following formula:

(price per share / EPS) / (expected EPS growth)

A calculation example:

Suppose we want to purchase shares but are still deciding between shares of Company A and shares of Company B. In this example, we use an investment horizon of 5 years.

Company A:

Share price: 5 euros

EPS: 10% or 50 cents

Expected growth: 10% per year

(5/0.5) / 10 = 1

Company B:

Share price: 10 euros

EPS: 3% or 30 cents

Expected growth: 8% per year

(10/0.3) / 8 = 4.17

How should one interpret the PEG ratio?

As a rule of thumb, any calculation result with a value below 1 is considered good. The stock is then undervalued. When looking at companies with very strong growth, for example in the tech sector, a value above 30 is certainly not uncommon, and such a stock is considered "expensive."