The Problem With P/E Alone
A P/E of 30× looks expensive for a slow-growth utility but cheap for a software company growing earnings at 40% per year. P/E ignores growth.
The PEG Ratio
Peter Lynch popularized the PEG ratio as a growth-adjusted valuation metric:
PEG removes the growth bias by normalizing P/E against growth expectations.
PEG Interpretation
| PEG | Signal |
|---|---|
| < 1.0 | Potentially undervalued relative to growth |
| = 1.0 | "Fairly priced" — paying exactly for growth |
| 1–2 | Moderate premium for growth |
| > 2 | Expensive relative to growth expectations |
Lynch's rule of thumb: A stock is attractively priced when PEG < 1. This heuristic works best for mid-cap growth companies; it's less reliable for mature, low-growth businesses.
PEG Limitations
- Growth estimates are uncertain — a missed earnings estimate changes PEG dramatically
- Less meaningful for value stocks and dividend payers
- Doesn't account for debt, margins, or capital intensity
- Best used as a screening tool, not a standalone buy/sell signal
Earnings Yield: Another P/E Derivative
Earnings yield (1 ÷ P/E × 100) converts valuation into a return metric. Compare it against 10-year Treasury yields — when earnings yield is close to or below bond yields, equities look less attractive on a risk-adjusted basis.
Use the P/E Ratio Calculator to compute trailing P/E, forward P/E, earnings yield, and PEG in one step.