Editor’s Note: In January 2025, Jim Pearce closed Personal Finance’s NVIDIA position at a 975% gain — using the same valuation discipline he applies to the PEG ratio today. When a stock’s price runs well past what its earnings growth can justify, there’s no room for disappointment. Read what he built after that exit →

A few days ago, my colleague Nathan Slaughter explained why investors should “Heed the Buffett Indicator.” In sum, the downside risk of owning equities increases when the total value of the domestic stock market far exceeds the value of our economic output.

That’s because there is an upper limit to how fast an economy can expand. Especially for a large and mature economy iwith an aging population such as the United States.

According to the US Bureau of Economic Analysis (BEA), “Real gross domestic product (GDP) increased at an annual rate of 2.0 percent in the first quarter of 2026.” Over the past ten years, the highest annual growth rate for GDP was 5.76 percent in 2021.

Of course, that number is a bit misleading since it followed a year of negative GDP growth due to the outbreak of the coronavirus pandemic that temporarily shut down large swaths of the economy. Over the past ten years the average growth rate for GDP in the United States has average a little under 2.5 percent.

Over the same span, the Wilshire 5000 Index – which is the stock market proxy commonly used in calculating the Buffett Indicator – more than doubled in value. As Nathan points out in his article, the index is now worth more than twice as much as GDP in the United States.

The PEG Ratio

Just as the Buffett Indicator provides a handy way of approximating the extent to which the stock market accurately reflects economic output, so too does the PEG (price/earnings-to-growth) ratio reflect the extent to which the price of an individual stock is consistent with its earnings potential.

If you are not familiar with the PEG ratio, it compares a stock’s P/E (price-to-earnings) ratio to the average growth rate of that company’s earnings over the recent past (usually five years).

A PEG ratio of 1.0 means that the P/E ratio for a stock is equal to that company’s average earnings growth rate. For example, a stock with a P/E ratio of 10 and an average earnings growth rate of 10 percent would have a PEG ratio of 1.0.

In that case, the stock in question would be considered fairly valued. But if a stock has a P/E ratio of 20 and an average earnings growth rate of 10 percent, its PEG ratio of 2.0 would be twice as high. Conversely, a stock with a P/E ratio of 10 and an average earnings growth of 20 would have a PEG ratio of 0.5, only half what would be considered fair value.

ALSO READ: “Three Questions You Should Ask Before Buying Any Stock“

Peer Pressure

I bring that up now because I believe the stock market is on thin ice due to the economic implications of the war in Iran. At the same time, the Buffett Indicator is near its all-time high while the PEG ratio for the S&P 500 is at 1.9, nearly twice its fair value.

As a stock market analyst, I can’t do anything about the Buffett Indicator other than be mindful of it when evaluating overall risk in the stock market. However, I can use the PEG ratio to help me determine the extent to which an individual stock may be mispriced relative to its sector peer group.

There isn’t much point in comparing the PEG ratio of an airline company to a tech stock. The airline industry survives on narrow margins and uses a lot of debt to leverage earnings. The tech sector thrives on wide margins, so it is less dependent on borrowed money to finance growth.

However, within the airline industry some companies are in better financial shape than others. The same is true for the tech sector, although the comparison is not as accurate due to wider differences in products and services.

Works Both Ways

Lately, I have been relying on the PEG ratio to great success in helping me generate trade ideas for my subscribers. A few weeks ago, I explained how I doubled my money in less than a month on an options trade for Delta Air Lines (NYSE: DAL). I chose Delta in part because of its low PEG ratio compared to its competitors.

However, a high PEG ratio can also be sued to identify overvalued stocks that might soon suffer a big drop. In those cases, a put option can be purchased rather than shorting the stock (a put option increases in value when the price of the underlying security goes down).

Since the start of the war in Iran, I have opened several put option trades based on the high level of the Buffett Indicator combined with equally high PEG ratios for companies that are vulnerable to elevated energy prices. It won’t take much in the way of bad news to send most of those stocks lower.

To be clear, I am not attempting to predict the long-term direction of an individual stock. All I am looking for is a set of conditions that suggest a stock is currently mispriced relative to its peer group and then make a leveraged trade that should be profitable if my thesis is correct.

I’m not always right, but I don’t need to be. The key to successful investing is having a repeatable system based on a set of rules that work more often than not, and the PEG ratio is one tool that can help you do that.

The PEG ratio is one of the most reliable valuation tools I’ve relied on throughout my career — and right now it’s flashing the same warning I saw in early 2025 when I closed Personal Finance‘s NVIDIA position after a 975% gain. My reasoning then was simple: when the PEG ratio on a stock or an entire market runs nearly twice its fair value, there’s no room for disappointment. The S&P 500’s aggregate PEG of 1.9 today tells me the same thing. I didn’t reinvest those NVIDIA proceeds into another mega-cap AI name. I built a different kind of portfolio around a different thesis. Here’s what it looks like →