A stock screen labels every PEG below one “cheap.” One number, one verdict.
Try two calculator examples. Both use a P/E of 20. One assumes annual earnings-per-share growth of 10%; the other, 20%. The second gets half the PEG, even though both put the same price on each dollar of earnings.
Growth has made the price look cheaper. The question is how much confidence that growth forecast deserves.
A price multiple divided by growth
The PEG ratio, short for price/earnings-to-growth, divides a P/E multiple by expected annual EPS growth.
At 10% growth, PEG is 20 ÷ 10 = 2. At 20% growth, it is 20 ÷ 20 = 1. Use the percentage number: 10 for 10%, not 0.10. Keep any decimals: 8.5% would enter as 8.5.
Growth here means earnings per share, the profit attributable to each share. Neither revenue growth nor total-profit growth belongs in this formula. You are pricing the growth of your slice of the business.
PEG is a comparison shortcut. A PEG of 2 does not mean you get your money back in two years.
Name the growth you are paying for
Return to Harbor's original earnings forecast, before the stress cut. Our fictional coffee business has a $66 year-end quote, FY3 EPS of $3.00 and a $3.24 FY4 consensus. Both EPS figures use the same GAAP diluted basis.
- Trailing P/E: $66 ÷ $3.00 = 22.
- Expected EPS growth: a $0.24 increase on $3.00, or 8%.
Its one-year PEG is 22 ÷ 8 = 2.75. Suppose you halve the growth forecast to 4%, keeping the price and trailing earnings fixed: 22 ÷ 4 = 5.50.
| Case | P/E | EPS growth | PEG |
|---|---|---|---|
| Harbor forecast | 22 | 8% | 2.75 |
| Half the growth | 22 | 4% | 5.50 |
Calculated from Harbor's teaching dataset and the half-growth scenario; both cover FY3 to the next fiscal year.
Halving expected growth doubles the price paid per unit of that growth.
Why one is only a shortcut
The familiar shorthand calls below one cheap, around one fair and above one expensive. But one only means the P/E and growth percentage match. There is no universal fair PEG.
A stable, slow-growing business can have a high PEG without being overpriced. A low PEG can belong to a risky business, or one that must reinvest nearly all its profit to grow. Damodaran's analysis explains why risk and the cost of producing growth still matter. Equal growth rates need not leave equal cash for owners.
Small forecast changes also hit harder when growth is low. At a P/E of 20, cutting growth from 5% to 2% lifts PEG from 4 to 10. The curve gets steeper as growth approaches zero.
Compare matching inputs
Compare businesses with similar risk and spending needs. Match the earnings definition, growth horizon and forecast source. A bank and a software company do not become peers because both have a PEG.
Provider conventions differ. Fidelity's glossary describes a PEG using forward P/E and a three-to-five-year annual EPS growth forecast. Our Harbor calculation uses trailing P/E and growth from FY3 to FY4. One good year is a different claim from several years of growth.
With forward P/E, check where the growth forecast starts. Higher next-year earnings already lower the P/E. If the growth rate includes that same jump, it lowers PEG again. That is two effects from one forecast, not two pieces of evidence that the price is attractive.
Where PEG breaks
Zero growth means dividing by zero: no PEG. Negative growth or losses can produce a negative number, but it is no cheapness signal.
For a cyclical business such as fictional Ironvale Steel, a profit rebound can fade; the P/E lesson's cycle warning still applies.
A tiny profit base creates another trap: a small dollar gain can look enormous as a percentage. Tessel Software, another fictional business, has a thin positive GAAP profit in FY3 after earlier losses. Its PEG offers little evidence of lasting growth. The next lesson turns to price-to-sales, which still leaves the profit question unanswered.
Harbor's checked result is a one-year PEG of 2.75. It does not tell you whether 8% growth can last beyond next year or justify the $66 price. You can calculate PEG correctly and still decide it adds too little to use.
For more depth, growth quality examines what growth costs; GARP and quality explores investing for growth at a reasonable price.
In short
- PEG divides P/E by annual EPS growth: enter 10 for 10%.
- Two PEGs are comparable only when their earnings and growth inputs line up.
- A PEG of one does not prove fair value; below one does not prove a bargain.
- Losses, tiny profits and brief rebounds can make PEG useless, even when the arithmetic works.