PEG Ratio: What Growth Costs in Valuation—and When It’s Worth It
Why the Price of Growth Isn’t the Same in Software, Soda, or Steel
At 25 times earnings, a stock looks expensive. But what if it’s doubling profits every year? Enter the PEG ratio—a deceptively simple calculation that claims to tell you if you’re paying too much for tomorrow’s growth, or if you’ve stumbled on a bargain the market missed.
The PEG (Price/Earnings to Growth) ratio: it’s the investing world’s attempt to have its cake and eat it, too. By dividing the P/E ratio by expected earnings growth, the PEG ratio promises to answer a question every investor faces: How much should I pay for growth?
When a Low PEG Is Not a Bargain—And a High PEG Is Not a Rip-Off
Textbooks whisper that a PEG of 1 is “fair value.” But markets—and sectors—never read the textbooks. In reality, the PEG ratio is less a universal yardstick and more a funhouse mirror, bending and distorting depending on the industry you’re in.
- Tech: PEGs of 1.5 or even 2 can be “cheap” if growth is genuinely explosive (and not just creative accounting).
- Consumer Staples: A PEG under 1 might not be a screaming buy—just a reflection of stable, slow-growing brands where growth is a rare flower.
- Industrials: Cyclicality plays havoc with PEG, as “growth” can evaporate with the business cycle. Today’s low PEG can be tomorrow’s value trap.
The PEG Ratio’s Secret Ingredient: Growth That Never Arrives
The PEG ratio’s promise is only as strong as the “G”—the expected growth rate. But whose growth rate? Analyst consensus? Management’s sunny projections? Your own cautious model?
Here’s where the PEG ratio becomes a Rorschach test:
- For software companies, rapid revenue growth may never translate to profits, making the “G” in PEG a moving target.
- For banks, accounting quirks and credit cycles make earnings growth notoriously lumpy—so PEGs can mislead.
- For mature industries, the PEG ratio often punishes the steady and rewards the risky. Sometimes, predictability is underpriced.
Why a PEG of 1 in Utilities Means Something Different Than in Biotech
Let’s take a closer look at PEG ratios across industries. The same number can mean radically different things depending on the business model, capital intensity, and the reliability of growth.
| Sector | Typical PEG Range | Hidden Subtleties |
|---|---|---|
| Technology | 1.2 – 2.0 | Growth rates volatile; high PEG may still be value if growth is sustainable |
| Consumer Staples | 0.8 – 1.2 | Slow, steady growth; low PEGs often reflect mature businesses, not bargains |
| Healthcare/Biotech | 1.0 – 3.0+ | Future growth highly uncertain; high PEGs can price in hope, not reality |
| Utilities | 0.7 – 1.1 | Regulated, predictable growth; PEGs often low for a reason—limited upside |
| Industrials | 0.9 – 1.3 | Cyclical earnings make “G” a moving target; beware the value trap |
Growth at Any Price? Beware the Mirage
A PEG below 1 can be a mirage—often signaling risk, not value. High-flying stocks in hot sectors can wear low PEGs thanks to wildly optimistic growth estimates, which rarely survive first contact with reality. Conversely, a high PEG in a mature sector may simply reflect the safety of slow, reliable growth.
When PEG Shines—and When It Blinds
The PEG ratio is best used as a conversation starter, not a final verdict. It shines in comparing companies within the same industry, where business models and growth prospects align. But cross-sector, it’s a recipe for confusion.
- Within software? PEG can help spot relative bargains or bubbles.
- Comparing a cloud company to a railroad? You’re better off comparing apples to space shuttles.
The Price of Growth: Context Is King
Growth is never free. Sometimes, it’s worth every penny; other times, it’s just hope in a fancy suit. The PEG ratio offers a lens—but it’s your responsibility to focus it, sharpen it, and understand when it distorts.
In the end, the cost of growth is not a number—it’s a judgment. And the PEG ratio is just the beginning.