PER: The key indicator every investor must master

If you have ever wanted to understand what is the PER of a stock, you have come to the right place. This ratio is probably the most used metric by analysts and investors when evaluating whether a company is trading at a good price or is overvalued. But here’s where it gets interesting: many people make the mistake of blindly trusting the PER without truly understanding how to interpret it.

Understanding the concept behind the PER

When we talk about what is the PER, we are actually referring to a very simple relationship: the price the stock market pays for each euro of profit the company generates. The acronym PER comes from the English Price/Earnings Ratio, that is, the Price/Earnings ratio.

Let’s imagine a company has a PER of 15. What does that mean? That the market capitalization of that company equals 15 times its annual profits. In other words, if the company maintained the same results, it would need 15 years of earnings to pay for its current stock price.

This metric is part of the six fundamental ratios that every investor should know:

• The PER (Price/Earnings)
• The EPS (Earnings Per Share)
• The P/BV (Price to Book Value)
• The EBITDA
• The ROE (Return on Equity)
• The ROA (Return on Assets)

How to calculate the PER: two paths leading to the same destination

Calculating the PER is surprisingly simple, and it can be approached from two different perspectives.

First approach: using global magnitudes

Here, divide the company’s total market capitalization by its annual net profit. If a company has a market cap of 2,600 million dollars and has generated profits of 658 million, its PER would be 3.95. This is the most direct way to do it.

Second approach: per-share focus

Alternatively, take the price of each share in the market and divide it by the earnings per share (EPS). If a share costs 2.78 dollars and its EPS is 0.09 dollars, the resulting PER will be 30.9.

Both methods give the same result because mathematically they are equivalent. The beauty of this ratio lies in the fact that the necessary data is accessible to anyone: you find it on any financial platform, whether under the name “PER” or “P/E” (more common on Anglo-Saxon platforms).

What do different PER levels reveal?

Interpreting the PER is not binary: it’s not simply “low good, high bad.” The market reality is more nuanced.

PER between 0 and 10: We are looking at a cheap company, but here comes an important warning: a low PER can indicate that markets expect a near-term decline in profits. Often, companies trading here are in trouble.

PER between 10 and 17: This range is considered optimal by most analysts. It suggests the company is reasonably valued and has growth potential without future profits seeming compromised.

PER between 17 and 25: Here we enter more speculative territory. It could mean the company has recently experienced significant growth, or that the market is aggressively betting on positive future results.

PER above 25: We are in maximum growth expectation territory. Market projections are very bullish, but there is also a higher risk that the company will not meet those expectations and suffer a severe correction.

The market is not always right: real cases

Not all PERs behave the same. Facebook (META) is a revealing example: for years, while its PER was falling, the stock price was rising. Why? The company was generating increasing profits, justifying lower multiples. But at the end of 2022, something changed: the PER kept decreasing, but the stock plummeted. Why? Central bank interest rate hikes penalized tech stocks especially, demonstrating that the PER alone does not tell the whole story.

Boeing presents a different case. Its PER has remained relatively stable while its stock experiences volatility. The key factor here is the sign: when the company generates profits, the PER is positive and behaves predictably; when it goes through years of losses, the PER becomes negative and loses all predictive capacity.

Shiller PER: the improved version

Some analysts question whether using only one year of profits is enough to properly evaluate a company. From this arises the Shiller PER, a variant that uses the average profits of the last 10 years, adjusted for inflation.

The logic behind this approach is solid: annual profits can be volatile, distorted by specific events or economic cycles. By using a full decade, the noise is smoothed out and a more realistic view is obtained. According to Shiller’s theory, this 10-year average allows for a more accurate projection of profits over the next 20 years.

Normalized PER: when you need depth

There is another interesting variant called normalized PER, which adjusts the calculation to better reflect a company’s true financial health.

Instead of using gross net profit, this approach considers free cash flow (Free Cash Flow). Additionally, when calculating market capitalization, liquid assets are subtracted and financial debt is added. The result? A more precise metric that separates operational reality from accounting artifices.

A historical case illustrates this well: when Banco Santander bought Banco Popular in 2017 for “one euro,” many sensational headlines spoke of the cheapest acquisition in history. The reality was different: Santander assumed a colossal debt that caused competitors like Bankia or BBVA to withdraw. The normalized PER would have immediately revealed this complexity.

The crucial comparison between sectors

This is where one of the most common mistakes among beginner investors resides: comparing the PER of companies from different sectors is like comparing apples to oranges.

Banks and heavy industry companies (like ArcelorMittal, with a PER of 2.58) typically trade at low multiples because they generate modest but predictable profits. In contrast, tech or biotech companies can have astronomical PERs. Zoom Video Communications, for example, reached a PER of 202 during the pandemic boom of video calls.

This does not mean Zoom was a terrible investment; it simply means the market was valuing exponential future growth expectations. Comparing this to a bank’s PER would be completely misleading.

Undeniable virtues of the PER

Despite its limitations, the PER offers concrete advantages:

It is extraordinarily accessible: anyone with an internet connection can calculate a PER in seconds. It requires no advanced math skills or hard-to-obtain data.

It serves as an effective initial filter: it allows quickly discarding obviously overvalued companies or identifying potential bargains in a specific sector.

Major investors and analysts use it constantly. Warren Buffett, despite his criticisms of purely quantitative analysis, religiously monitors PER.

It works even when there are no dividends, making it versatile for any type of company.

The weaknesses of the PER: it’s not perfect

The PER also has genuine limitations that we cannot ignore:

It relies solely on profits from the last year. If those profits were abnormal (for example, due to an asset sale), the PER will mislead you completely.

It’s useless for companies without profits. Fast-growing startups that are not yet profitable have an indefinite or negative PER, which the ratio cannot process.

It reflects a static snapshot, not a movie. A company may have a magnificent PER today but be two years away from insolvency if management is incompetent.

Cyclical companies distort the indicator. A mining company at the peak of its economic cycle will have a low PER (because profits are at maximum), but this is precisely the riskiest moment. When the cycle falls, the PER explodes.

Combining the PER with other tools

Here is the key: no ratio is an island. The PER should be accompanied by other indicators to build a robust assessment.

Consider the ROE (Return on Equity): reveals if the company uses shareholders’ capital efficiently. A low PER but also low ROE is a red flag.

Analyze the ROA (Return on Assets): shows how much profit each euro of assets generates. A low PER but decreasing ROA indicates operational efficiency is declining.

Study the profit composition: does it come from the core business or secondary operations? Profit inflated by property sales is not as valuable as profit generated by commercial operations.

Value Investing and the obsession with the PER

Fund managers specializing in value investing (search for solid companies at good prices) live by the PER. Funds like Horos Value Internacional trade at a PER of 7.24, significantly below the 14.56 of their category average. Cobas Internacional, with a similar philosophy, operates with a PER of 5.46.

This difference is no accident: these managers build their portfolios by identifying companies with low PER but solid fundamentals. It’s the art of finding gems on discount.

Conclusion: the PER is a tool, not an oracle

The PER is genuinely useful, but only if used correctly. It’s excellent for initial screening of companies, for comparing firms within the same sector, and for spotting obvious valuation discrepancies.

But here’s the secret many don’t grasp: a low PER does not guarantee a good investment. The history is full of cheap companies that went bankrupt because of poor management. Likewise, companies with high PERs are often the ones that later multiply the investment.

Therefore, the correct approach is: use the PER as a starting point, not as an endpoint. Spend time truly understanding what that company does, who runs it, and what its competitive position is. Combine the PER with EPS, ROE, ROA, and a deep analysis of its financial statements.

Only then will you have a solid foundation to make investment decisions that truly enrich you.