Stock Valuation Ratios 101: P/E, PEG, and PEGY (With Easy Formulas & Examples)

Pricing a stock without context is like buying a house without checking the neighborhood. Stock valuation ratios help you judge whether you’re paying a fair price for the business you’re buying. Three simple but powerful tools are the Price to Earnings ratio (P/E ratio), the PEG ratio, and the PEGY ratio. Used correctly, they help you compare companies, balance growth against price, and factor in dividends.

Let’s have a basic understanding of these ratios in detail.

• P/E Ratio: How many dollars investors pay for each dollar of current earnings.
• PEG Ratio in stocks: P/E adjusted for expected earnings growth.
• PEGY Ratio explained: PEG further adjusted for dividend yield.

P/E Ratio (Price to Earnings)

The P/E ratio tells you how expensive a stock is relative to its earnings. High P/E often implies higher growth expectations; low P/E can suggest value or trouble.

\[\mathrm{P/E}=\frac{P}{\mathrm{EPS}}\]

Trailing P/E: uses the last 12 months (LTM) EPS.

Forward P/E: uses next year’s expected EPS.

Example

• Price = $50
• Trailing EPS = $2.50
• P/E = 50 / 2.50 = 20

Interpretation: Investors are paying $20 for each $1 of earnings.

When to use?

• Works best: Companies with stable, positive earnings (e.g., mature consumer staples, banks with steady profits).
• Use caution / avoid:
  • Negative earnings (P/E is meaningless).
  • Highly cyclical industries (boom/bust EPS can distort P/E). Consider normalized earnings or multi-year averages.
  • Accounting-heavy sectors where EPS is noisy (large one-offs).

Drawbacks & limitations

• Ignores growth—a 20 P/E can be cheap for a fast grower and expensive for a slow one.
• Sensitive to accounting choices, buybacks, and one-time items.
• Cyclical traps: peak earnings make P/E look low right before a downturn.

PEG Ratio (Price/Earnings-to-Growth)

he PEG ratio adds context by dividing P/E by the company’s earnings growth rate. It asks: Am I paying a fair price for the growth I expect?

\[\mathrm{PEG}=\frac{\mathrm{P/E}}{\mathrm{EPS\ Growth}(\%)}\]

Important: Most investors use the growth rate as a whole percentage, not a decimal.
Example: 15% growth → use 15 (not 0.15). Be consistent.

Rule of thumb:

• PEG ≈ 1 → “fair” for its growth
• PEG < 1 → potentially undervalued (growth at a reasonable price)
• PEG > 1 → potentially expensive for its growth

Example

• From above, P/E = 20
• Expected EPS growth = 15%
• PEG = 20 / 15 = 1.33

Interpretation: You’re paying a slight premium relative to growth.

When to use?

• Works best: Growth stocks with reasonably predictable growth (secular growers, recurring-revenue models).
• Use caution / avoid:
  • Low/zero/negative growth → PEG becomes large or meaningless.
  • Very volatile growth (turnarounds, commodity plays).
  • Young/unprofitable companies (no P/E, so no PEG).

Drawbacks & limitations

• Forecast risk: depends on future growth estimates that can be wrong.
• Assumes linear growth—real growth is lumpy.
• Penalizes mature compounders: solid but modest growers can look “expensive” on PEG despite excellent quality and cash returns.

PEGY Ratio (Price/Earnings to Growth and Yield)

The PEGY ratio adjusts PEG by adding dividend yield to the growth rate—useful when dividends are a meaningful part of total return.

\[\mathrm{PEGY}=\frac{\mathrm{P/E}}{\mathrm{EPS\ Growth}(\%)+\mathrm{Dividend\ Yield}(\%)}\]

Example

• P/E = 20
• Growth = 15%
• Dividend yield = 3%
• PEGY = 20 / (15 + 3) = 20 / 18 = 1.11

Interpretation: Accounting for dividends, the valuation looks more reasonable than the PEG alone (1.33).

When to use?

• Works best: Dividend-paying growth stocks, mature firms with steady payouts.
• Use caution / avoid:
  • Unsustainable dividends (payout cuts will break the logic).
  • Highly leveraged companies funding dividends with debt.
  • No-dividend companies (PEG may be enough).

Drawbacks & limitations

• Ignores payout sustainability—a high yield can be a red flag.
• Still relies on growth forecasts.
• Treats dividends and growth as equivalent contributors, which may not reflect reinvestment needs or tax differences.

Metric	Best for	Avoid/Use Caution	Strength	Main Weakness
P/E	Profitable, stable earners	Negative/volatile EPS; deep cyclicals	Simple, universal starting point	Ignores growth and capital returns
PEG	Predictable growth companies	Zero/negative/erratic growth	Prices growth explicitly	Forecast-heavy; assumes linear growth
PEGY	Dividend-paying growers	Unsustainable/high-risk yields	Prices growth explicitly	Yield may mislead; still forecast-heavy

How does famous investors use these ratios

Warren Buffett

• Prefers earnings yield (E/P) and discounted cash flows, often comparing earnings yield to bond yields as a sanity check.
• Focuses on business quality, moats, and owner earnings (cash generation), not just low P/E.
• Takeaway: Treat P/E, PEG, PEGY as signals, but anchor decisions in cash flows, quality, and opportunity cost (what bonds yield).

Peter Lynch

• Popularized the PEG ratio to find “growth at a reasonable price.”
• Rule of thumb: PEG around 1 is reasonable, lower can be attractive—if the business is sound and growth believable.
• Takeaway: PEG is powerful for stock picking—but only with realistic growth assumptions.

Benjamin Graham

• Early emphasis on low P/E and margin of safety.
• Used conservative assumptions and quality filters to avoid value traps (e.g., adequate financial strength).
• Takeaway: Ratios help identify cheapness, but insist on safety and quality to protect downside.

How investors use P/E, PEG, PEGY together

1. Start with P/E to spot outliers vs. sector/market history.
2. Layer in PEG to check if the price matches growth expectations.
3. Use PEGY when dividends are meaningful to total return.
4. Cross-check with earnings yield, free cash flow, and debt.
5. In cyclicals, use multi-year averages (e.g., 5–10 year normalized EPS or CAPE-style thinking).
6. Always test quality (margins, returns on capital, moat) and risk (leverage, customer concentration).