Track 03 · Valuation Basics
P/E and PEG: what you pay for a dollar of profit
How the most-quoted valuation ratio is built, when it misleads, and how growth adjusts it.
The band is the context: the same P/E reads differently against a company’s five-year history than against a bare number.
- 1Bottom of range. A low multiple with debt and falling margins is cheap for a reason — check the balance sheet.
- 2Multiple expanded. Same earnings, higher P/E: the price now discounts a lot of expected growth. PEG divides it by that growth.
Illustrative. Interest rates set the baseline: a multiple normal in a 1% rate world is rich in a 5% world.
How P/E is calculated
Price divided by earnings per share. A P/E of 20 means you pay $20 for every $1 of annual profit, roughly 20 years of current earnings at today’s price.
It is a price tag rather than a judgement: a high P/E says the market expects growth, a low P/E says it expects trouble or gives the company no credit for either.
Trailing vs forward
Trailing P/E uses the last twelve months of reported earnings; forward P/E uses analyst estimates for the next year. Forward looks ahead but inherits every error in those estimates.
When the two diverge sharply, the market is pricing a large expected change, worth understanding before you act on either number.
Read a multiple in context
Interest rates set the baseline: when risk-free yields rise, investors can demand more from stocks, which compresses multiples across the market. A P/E that was normal in a 1% rate world is rich in a 5% world.
Sector norms differ hugely: utilities at 15 and software at 35 can both be fairly priced. The comparison that matters is against peers and against the company’s own history.
- Compare within the sector, never across it.
- Check the multiple against the 5-year range.
- Ask what growth rate justifies the premium.
PEG: growth-adjusted
PEG divides P/E by the expected annual earnings growth rate. A P/E of 30 with 30% growth gives a PEG of 1.0, one point of multiple per point of growth.
Below 1.0 suggests growth is cheaply priced; well above 1.0 means the price already discounts a lot of good news. It works best on growing companies and breaks down entirely when growth is negative or wildly uncertain.
Three things to remember
- 01P/E is the price per dollar of current earnings; the level reflects expected growth and interest rates.
- 02Compare multiples to peers and to the company’s own history rather than to a universal number.
- 03PEG adjusts for growth: around 1.0 is fairly priced by this measure.
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