Investopedia defines a peg ratio as:
A stock’s price-to-earnings ratio divided by the growth rate of its earnings for a specified time period. The price/earnings to growth (PEG) ratio is used to determine a stock’s value while taking the company’s earnings growth into account, and is considered to provide a more complete picture than the P/E ratio. While a high P/E ratio may make a stock look like a good buy, factoring in the company’s growth rate to get the stock’s PEG ratio can tell a different story. The lower the PEG ratio, the more the stock may be undervalued given its earnings performance. The calculation is as follows:
P/E ratio ÷ Annual EPS Growth
What’s nice about using this ratio?
By using this PEG ratio as opposed to just the PE ratio, you are going to see a truer reflection of the value in the share. You are basically seeing the multiple of times a share is trading above its earnings relative to it’s growth.
Example: Take a company whose PE is 40, it seems expensive, but most people will say that is has growth underlying in the price. In order to see those words in numbers, use the PEG ratio.
Watch the video here explaining the PEG ratio.