The PEG ratio compares a stock's Price to earnings ratio to it's expected Earnings per Share.
The formula is:
P/E divided by the expected growth rate
or
(Price/Earnings)/Growth
Some investors consider a company to be overpriced if it's PEG ratio is greater than 1. This indicates that the market expects earnings to be higher in future years. A PEG ratio of less than 1 suggests the stock may be undervalued.
Example: A sock company has a market price of $25 and EPS of $2. The P/E would be 15/2 = 12.5
The company's growth over the past few years has averaged 20% per year. The PEG ratio would be (25/2)/20=0.625
The PEG ratio is very sensitive to short run changes in price, earnings and earnings growth. Average growth rates are often used rather than growth rates from the previous period. Note also that the growth rate is the percentage growth x 100.