What is PEG Ratio in Stock Market

The PEG ratio, or Price/Earnings to Growth ratio, is an advanced valuation metric often used in the stock market to complement the traditional Price-to-Earnings (P/E) ratio. By incorporating growth, it provides a more balanced view of whether a stock is overvalued, undervalued, or fairly priced. Investors and analysts use it to assess companies across sectors, particularly those expected to deliver sustainable growth.

The PEG ratio is a financial metric that compares a company’s Price-to-Earnings (P/E) ratio with its expected earnings growth rate. While the P/E ratio evaluates the price paid for each unit of earnings, the PEG ratio adds another layer by factoring in growth expectations. A PEG close to 1 is often interpreted as a stock being fairly valued relative to its growth prospects.

In the stock market, the PEG ratio helps measure the relationship between the valuation of a stock and its future growth potential. It provides context to the P/E ratio, which on its own might be misleading. For example, two companies may have the same P/E ratio, but the one with higher growth prospects could appear more attractive when assessed with the PEG ratio.

This makes PEG particularly useful when comparing companies across industries where growth patterns differ significantly.

The PEG ratio plays a significant role in stock market analysis because:

• It balances valuation with growth prospects, offering more context than the P/E ratio alone.
  

• A PEG of around 1 is often seen as a reasonable alignment between price and growth.
  

• It helps identify stocks that may appear expensive on P/E but are justified due to strong growth expectations.
  

• It allows for more effective cross-industry comparisons, particularly between growth and value stocks.

Despite its usefulness, PEG ratio has limitations:

• Relies on forecasted growth rates, which may be inaccurate.
  

• May not suit cyclical industries where earnings fluctuate.
  

• Assumes growth is constant, which is rarely true in practice.
  

• Does not account for qualitative factors such as management quality or market risks.

Consider Company A and Company B:

• Company A: P/E = 30, Growth rate = 20% → PEG = 30 ÷ 20 = 1.5
  

• Company B: P/E = 25, Growth rate = 25% → PEG = 25 ÷ 25 = 1.0
  

Although Company A has a higher P/E, Company B appears more fairly valued when growth is considered. This demonstrates why PEG ratio can provide more meaningful insights than P/E alone.

The PEG ratio is a useful valuation tool that bridges the gap between current earnings and future growth expectations. By combining P/E with growth, it allows investors to evaluate companies more comprehensively. However, since it relies on projected growth rates, it should be applied with caution and ideally used alongside other valuation methods for a complete picture.

This valuation method should not be considered for taking any investment decisions. This content is for informational purposes only and the same should not be construed as investment advice. Bajaj Finserv Direct Limited shall not be liable or responsible for any investment decision that you may take based on this content.