How to Calculate PEG Ratio and Find Undervalued Growth Stocks

What the PEG Ratio Actually Measures

The price-to-earnings ratio tells you what the market charges per dollar of current earnings. It tells you nothing about what those earnings will look like in three years. The PEG ratio corrects that blind spot.

The formula is straightforward:

PEG Ratio = (Price / EPS) / Annual EPS Growth Rate

Or in plain terms:

PEG = P/E Ratio / EPS Growth Rate (%)

The growth rate is expressed as a whole number. A company growing EPS at 22 percent per year uses 22 in the denominator, not 0.22.

Peter Lynch popularized this metric in One Up on Wall Street and set 1.0 as the threshold for fair value. Below 1.0, the stock's growth rate justifies its price multiple. Above 1.0, investors are paying a premium. Above 2.0, that premium demands exceptional confidence in the growth forecast.

Why P/E Alone Misleads Growth Investors

Consider two stocks. Stock A trades at a P/E of 18x. Stock B trades at a P/E of 36x. The reflexive conclusion is that Stock A is cheaper.

Now add growth rates. Stock A grows EPS at 8 percent per year. Stock B grows EPS at 40 percent per year.

PEG for Stock A: 18 / 8 = 2.25 PEG for Stock B: 36 / 40 = 0.90

Stock B, the one that looked expensive, is the better-valued growth investment. Stock A is paying a 125 percent premium relative to its growth. That is the error that P/E-only screening produces at scale.

The PEG Ratio Formula: Step-by-Step Calculation

Step 1: Find the Trailing or Forward P/E Ratio

You can use trailing twelve months (TTM) P/E for historical accuracy, or forward P/E for forward-looking comparisons. Be consistent. Mixing TTM P/E with forward growth estimates distorts the output.

For a stock trading at $142.00 with TTM EPS of $6.20:

P/E = $142.00 / $6.20 = 22.9x

Step 2: Determine the EPS Growth Rate

Use a five-year analyst consensus growth estimate for forward PEG. For trailing PEG, use the compound annual growth rate (CAGR) over the past three to five fiscal years.

If EPS grew from $3.80 five years ago to $6.20 today:

CAGR = (6.20 / 3.80)^(1/5) - 1 = 10.28 percent

Round to 10.3 for the calculation.

Step 3: Calculate PEG

PEG = 22.9 / 10.3 = 2.22

At 2.22, this stock prices in strong future performance with almost no room for a growth deceleration. A single missed earnings quarter could trigger a 15 to 25 percent multiple compression.

Worked Example 1: Identifying an Undervalued Growth Stock

A mid-cap software company shows the following data:

• Current share price: $88.50
• TTM EPS: $2.14
• Five-year forward EPS growth estimate (consensus): 31 percent per year

P/E = $88.50 / $2.14 = 41.4x

At first glance, 41.4x looks expensive. Many value-oriented screens would filter this stock out immediately.

PEG = 41.4 / 31 = 1.34

A PEG of 1.34 is moderately above fair value, but not stretched. For a software business with recurring revenue, 30-plus percent EPS growth, and strong free cash flow conversion, the market is pricing in realistic, not heroic, assumptions.

Now assume you invest $75,000 at this price point and the stock re-rates to a PEG of 1.0 over 18 months, while EPS grows as projected.

Projected EPS in 18 months: $2.14 x (1.31)^1.5 = $2.99

At a PEG of 1.0 and 31 percent growth: Target P/E = 31x Target price: $2.99 x 31 = $92.69

That represents a 4.7 percent gain from valuation normalization alone, before any EPS upside surprise. The point is not the specific return. The point is that the PEG ratio gave you a quantifiable framework for entry.

Worked Example 2: Avoiding an Overvalued Name

A consumer technology company presents this picture:

• Current share price: $310.00
• TTM EPS: $5.60
• Five-year forward EPS growth estimate: 14 percent per year

P/E = $310.00 / $5.60 = 55.4x

PEG = 55.4 / 14 = 3.96

A PEG of 3.96 means the market prices in four times the company's own growth rate. To justify this valuation at a PEG of 1.0, the company would need to grow EPS at 55.4 percent per year, not 14 percent.

If you deploy $100,000 into this position and growth disappoints even modestly, the multiple contracts sharply. Assume EPS growth comes in at 10 percent instead of 14 percent over two years. The market re-rates to a PEG of 2.0.

EPS in two years: $5.60 x (1.10)^2 = $6.77

Fair P/E at PEG 2.0 and 10 percent growth: 20x Target price: $6.77 x 20 = $135.40

That is a 56.3 percent drawdown on a $100,000 position, producing a loss of $56,300. The P/E ratio never flagged this risk. The PEG ratio did, from day one.

PEG Ratio Benchmarks by Sector

The 1.0 rule is a starting point, not a universal standard. High-multiple sectors carry different baseline PEG ranges.

Comparing a software stock's PEG of 1.8 against a utility's PEG of 1.8 draws a meaningless conclusion. Compare within sectors and against a company's own historical PEG range.

Three Limitations You Cannot Ignore

Growth Estimates Are Forecasts, Not Facts

Analyst consensus EPS growth estimates carry a median error of 8 to 12 percentage points over a five-year horizon. A company forecast at 25 percent growth often delivers 13 to 17 percent. Run PEG calculations at the consensus rate, then stress-test at 60 percent and 40 percent of that estimate.

EPS Can Be Engineered

Share buybacks reduce the share count and inflate EPS growth without any improvement in underlying business performance. A company generating flat net income but buying back 5 percent of shares annually shows 5 percent EPS growth. Verify that earnings growth reflects revenue expansion or margin improvement, not financial engineering.

Negative EPS Makes PEG Useless

Pre-profit companies have no usable P/E ratio. For those businesses, price-to-sales growth or EV/revenue-to-growth ratios serve a similar purpose. Do not force the PEG framework onto companies that have not reached profitability.

Using the PEG Ratio Inside a Broader Valuation Process

The PEG ratio answers one question: does this stock's price reflect its earnings growth rate fairly? It does not assess balance sheet quality, competitive positioning, free cash flow yield, or management capital allocation.

Treat PEG as a first filter, not a final verdict. A PEG below 1.0 warrants deeper analysis. A PEG above 3.0 demands an extraordinarily clear thesis before capital commits.

The practical workflow:

1. Screen for PEG below 1.5 within a target sector.
2. Eliminate companies with debt-to-EBITDA above 4.0x.
3. Confirm that EPS growth correlates with revenue growth, not buyback-driven EPS inflation.
4. Check the company's five-year PEG range. A PEG of 1.2 is different for a company that historically trades at 0.8 versus one that trades at 2.0.
5. Model the position at two growth scenarios: consensus and a 35 percent haircut to consensus.

Run the Numbers Before You Commit Capital

The PEG ratio takes less than 30 seconds to calculate once you have the inputs. The challenge is sourcing consistent data, stress-testing growth assumptions, and modeling position outcomes across multiple scenarios.

The CalcMoney Investment Calculator lets you input a stock's current price, EPS, and growth rate, then model how changes in each variable affect fair value and projected returns. Before you size any growth position, run the scenarios first.

Use the CalcMoney Investment Calculator to model PEG-based valuations on your watchlist →

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The math takes seconds. The decisions it informs are worth far more than that.