Peter Lynch, one of the greatest fund managers of all time, uses PEG as a 'number worth noticing'.
"The P/E ratio of any company that's fairly priced will equal its growth rate...In general, a P/E that's half the growth rate is very positive, and one that's twice the growth rate is very negative. We use this measure all the time when analyzing stocks for the mutual funds."
PEG ratio can be calculated based on past earnings growth or future expected growth rate, but Peter Lynch has the following advice:
"If your broker can't give the company's growth rate, you can figure it out for yourself by taking the annual earnings from Value Line or an S&P report and calulating the percent increase in one year to the next. That way you'll end up with another measure of whether a stock is or is not too pricey. As to the all-important future growth rate, your guess is as good as mine"
We calculate PEG as follows:
A PEG ratio of less than 0.5 is considered attractive, while ratios above 2 are unattractive.
It should be noted that PEG cannot be used on all companies. Cyclical companies for instance will have a low PEG ratio but buying these stocks at a low point is a proven method for losing half your money in a short period of time. Conversely, companies who had a few tough years will show a high PEG ratio but business could soon pick up.