How do I calculate the PEG ratio and find the correct earnings growth rate to use?

You calculate the PEG ratio by dividing a company’s P/E ratio by its annual earnings growth rate. The part that often causes confusion is this: if earnings growth is 20%, you use 20 in the PEG formula, not 0.20.

PEG = P/E ratio ÷ annual earnings growth rate expressed as a percentage number.

But where does that growth rate come from? Let us build it from the beginning.

Imagine Mama Ngozi wants to buy shares in a business. She should not look at the share price alone. She also wants to know how much profit each share represents and whether that profit is growing.

That is what PEG tries to connect: the price you are paying for today’s earnings and how quickly those earnings may grow.

Here is how to calculate it, using made-up figures.

1. Calculate the P/E ratio.

Suppose the share price is ₦60, and the company’s annual earnings per share is ₦5.

Earnings per share, called EPS, means the profit belonging to each ordinary share. It is not the dividend paid to shareholders.

P/E = Share price ÷ annual EPS.

₦60 ÷ ₦5 = 12.

So, the P/E ratio is 12. You are paying ₦12 for every ₦1 of annual earnings.

2. Find the earnings growth rate.

For PEG, you generally want growth in EPS, not growth in sales, dividends or the share price.

There are two main ways to obtain it.

You can calculate historical growth from published financial reports. Suppose EPS rose from ₦4 in the previous financial year to ₦5 in the latest financial year.

Annual EPS growth = ((New EPS ÷ Old EPS) − 1) × 100.

((₦5 ÷ ₦4) − 1) × 100 = 25%.

This tells you earnings per share grew by 25% over that year. It does not tell you they will grow by 25% next year.

Alternatively, you can use expected future EPS growth. PEG is commonly used with forecast annual earnings growth, often over the next three to five years. However, data providers use different periods and methods, so there is no single growth figure that is automatically “correct” for every PEG calculation.

Look for forecasts in research reports from reputable stockbrokers or investment research providers. Check the report’s date, forecast period and assumptions. A forecast is an estimate, not a promise.

3. If using several years, calculate the yearly compounded growth.

Suppose EPS increased from ₦4 to ₦6.912 over three years.

The total increase is 72.8%, but you should not put 72.8 into PEG as though it were the yearly growth rate. Simply dividing it by three is also not the correct compounded calculation.

Use the compound annual growth rate, called CAGR:

CAGR = ((Ending EPS ÷ Starting EPS) raised to the power of (1 ÷ number of years) − 1) × 100.

For this example:

((6.912 ÷ 4) raised to the power of (1 ÷ 3) − 1) × 100 = 20%.

That means EPS grew at an equivalent compounded rate of 20% a year. There are three yearly intervals between the starting and ending figures.

4. Put the annual growth number into PEG.

Using a P/E of 12 and annual EPS growth of 20%:

PEG = 12 ÷ 20 = 0.6.

Not 12 ÷ 0.20, which would incorrectly give you 60.

Now, how do you choose a sensible growth rate?

Start with the company’s annual reports, available through its investor relations website or Nigerian Exchange disclosures. Compare full-year EPS figures, preferably on the same basis. Diluted EPS, where reported, accounts for potential extra shares that could reduce earnings per share.

Check whether growth came from normal business activity or something unlikely to repeat, such as selling a building. Also watch for a recovery from unusually low profits. That can produce a huge growth percentage that makes PEG look misleadingly cheap.

If reliable forecasts are unavailable, you can use a three-to-five-year historical EPS CAGR as a backward-looking guide. Label it clearly. Do not present past growth as expected future growth.

Also check whether the P/E uses past annual earnings or forecast earnings. When comparing PEG figures, use a consistent method and forecast period.

A PEG below 1 is sometimes described as potentially cheap relative to growth. It is not a buy signal. Debt, weak cash flow, unreliable forecasts and temporary profits can still make the investment poor. PEG is generally not useful when earnings or growth are zero or negative.

The main lesson is simple: the division is easy. The real work is choosing an annual EPS growth rate that is clearly sourced, correctly calculated and reasonable to expect.