Unveiling the PER: The Fundamental Metric That Defines Stock Valuation

The fundamental analysis of a listed company is based on several key indicators, but there is one that stands out for its versatility and simplicity: the Price/Earnings Ratio, better known by its acronym PER. This indicator, along with EPS (Earnings Per Share or EPS in Anglo-Saxon terminology), constitutes the cornerstone for any investor who wishes to properly assess a company’s status before making investment decisions.

The Essence of PER: Beyond a Simple Quotient

PER acts as a mirror of the relationship between what the market pays for a company and what it generates in profits. The initials correspond to its English nomenclature: Price/Earnings Ratio, a concept that allows you to understand at a glance how many years it would take for current profits to match the company’s market capitalization.

Within the ecosystem of ratios that make up fundamental analysis, PER aligns with other essential metrics: EPS, P/BV (Price/Book Value), EBITDA, ROE (Return on Equity), and ROA (Return on Assets). The peculiarity of PER lies in providing information both for comparison between companies and as an indicator of the temporal growth a company experiences.

When we see that a company has a PER of 15, it means that its extrapolated profits over 12 months would require 15 years to fully amortize the value assigned by the stock market. However, reality shows that these indicators behave very heterogeneously depending on external and internal factors.

Understanding PER Behavior in the Market

The recent history of Meta Platforms (formerly Facebook) illustrates how PER can disappear while the stock price skyrockets. For years, when PER decreased progressively, the share price rose correspondingly—evidence that the company substantially increased its profits period after period. This scenario changed drastically at the end of 2022, when the share price plummeted despite PER continuing to decline. The explanation: market expectations for tech stocks collapsed amid tightening monetary policies.

In contrast, companies like Boeing exhibit different dynamics, where PER remains relatively stable within a certain range while the stock fluctuates significantly. What is particularly revealing in cases like this is that a change in the sign of profits (from positive to negative or vice versa) marks decisive turning points in valuation.

It is important to note that the PER as we study it applies specifically to publicly traded companies. Private companies, lacking quarterly financial disclosure obligations, require more in-depth and laborious analysis.

Calculation Methodology: Two Approaches, One Result

The determination of PER can be approached from different perspectives without fundamentally altering the results. The conventional method divides the company’s total market capitalization by its aggregate net profits. Alternatively, the same ratio can be obtained using the individual stock price in the numerator and EPS (Earnings Per Share) in the denominator.

Both formulas operate easily because the required data are accessible and publicly available:

Formula 1: Market Capitalization ÷ Total Net Profit

Formula 2: Stock Price ÷ Earnings Per Share (EPS)

The accessibility of these data allows any investor to perform the calculation independently without specialized tools.

Locating and Identifying PER on Financial Platforms

Finding PER on any financial news medium is a trivial task. Virtually all stock databases include this metric along with complementary information such as market capitalization, EPS, 52-week price ranges, and number of shares outstanding.

It is relevant to note that nomenclature varies by geography. In Spanish platforms, it usually appears under the acronym PER, while in U.S. and UK portals, it is often presented as P/E. Information on Spanish construction companies like ACS on local platforms clearly shows this designation, whereas on services like Yahoo! Finance (focused on North American markets), Tesla and other assets appear under the acronym P/E.

Practical Examples of PER Calculation

To materialize these concepts, consider two real cases:

Case 1 - Corporate Level Analysis: A company has a market capitalization of 2.6 billion dollars and generated net profits of 658 million dollars in the last fiscal year.

Applying the formula: 2,600 ÷ 658 = PER of 3.95

Case 2 - Share Level Analysis: An investment alternative offers shares at $2.78 each, with an EPS of $0.09.

Applying the formula: 2.78 ÷ 0.09 = PER of 30.9

The substantial difference between both results reflects how growth-phase companies present higher ratios than established ones.

Variants of PER: Adaptations for Deeper Analysis

Shiller PER: Extended Time Horizon Perspective

There is a variant that some analysts consider more robust than the conventional PER: the Shiller PER. The fundamental distinction lies in the time horizon used. While traditional PER considers only 12 months of profits (a period critics consider excessively short and susceptible to volatility), the Shiller PER extends the observation window to 10 years.

The Shiller PER methodology divides market capitalization by the average of profits over the last decade, adjusted for inflation. The underlying theory holds that this extended period allows for more reliable projections of the company’s performance over the next 20 years. Although it has enthusiastic supporters, it also faces criticisms similar to those directed at its conventional version.

Normalized PER: Adjustments for Financial Health

Another relevant expression is the normalized PER, which emphasizes the company’s actual financial condition rather than the specific measurement period. Its calculation requires taking the market capitalization, subtracting available liquid assets, and adding total financial debt. In the denominator, instead of conventional net profit, the Free Cash Flow (free cash flow) is used.

This refinement effectively discriminates between genuine operational profits and one-time gains from asset sales. The paradigmatic case was the acquisition of Banco Popular by Banco Santander—formally recorded as a purchase for 1 euro, but in reality involving the assumption of enormous debt that caused institutions like Bankia or BBVA to withdraw from the operation.

Practical Utility: When and How to Apply PER

PER stands out as a highly effective comparative tool, allowing quick identification of whether a company is undervalued or overvalued within its sector. A high PER suggests that the company is trading at disproportionate levels relative to its profit-generating capacity, while a low PER often indicates attractive buying opportunities.

The conventional interpretation establishes reference ranges:

• 0-10: Prima facie attractive, though it may signal future deterioration of profits
• 10-17: Preferred zone for analysts, suggests balanced growth without compromising expectations
• 17-25: Indicates possible recent overgrowth or formation of a valuation bubble
• More than 25: Ambiguous by nature—may reflect extraordinarily optimistic projections or speculative illusion

However, this initial reading requires significant nuance. Successful investing cannot be based solely on PER. The market often undervalues legitimate companies for prolonged periods, but when PER remains consistently low, it generally reflects deep management problems or insolvency proximity.

PER as a Compass for Value Investing

Value Investing adherents—philosophy seeking excellent companies at fair prices—use PER extensively as a guiding indicator. Representative funds of the international Value approach such as Horos Value Internacional FI show a PER of 7.24, significantly below the sector average of 14.56. Similarly, Cobas Internacional FI presents a PER of 5.47, highlighting this investment school’s preference for companies with depressed ratios.

Sector Dynamics: PER Not Universal

A critical aspect often overlooked is that correct interpretation of PER must always contextualize comparison within the same sector. Different industries naturally exhibit disparate PER ranges.

Traditional sectors like banking and heavy industry typically maintain low PERs. ArcelorMittal, a leader in metallurgy, shows a PER of 2.58. Conversely, technology and biotech companies operate with substantially higher PERs. Zoom Video, massively popularized during the shift to remote work, recorded a PER reaching 202.49.

Comparing the PER of a bank with that of a biotech company lacks analytical validity. A valid comparison requires “apples with apples”—only among assets within the same sector and geography, under homogeneous market conditions.

Integration with Other Fundamental Indicators

The PER ratio alone lacks significance without being complemented by other indicators. A rigorous analysis should incorporate EPS, P/BV, ROE, ROA, RoTE (Return on Tangible Equity), and, crucially, a detailed examination of the internal composition of profits.

A high profit in a given period may result from extraordinary operations—sale of financial assets, non-operating gains—rather than robust core business development. Without this in-depth analysis, PER becomes a misleading metric.

Strengths and Limitations of the Indicator

Unquestionable Advantages

• Easy to obtain and calculate, accessible even for novice investors
• Comparative efficiency among sector companies without requiring complex analysis
• Universal acceptance among investors and professional analysts
• Works for comparisons even when companies do not pay dividends

Significant Weaknesses

• Depends solely on 12-month profits, a potentially insufficient horizon
• Not applicable to loss-making companies
• Captures a static snapshot, not the company’s dynamic trajectory
• Particularly problematic in cyclical companies, which show low PER at cycle peaks and high PER at depressed troughs

Summary: Use PER Prudently

PER maintains unequivocal relevance within fundamental analysis, especially effective for comparative evaluations within homogeneous sectors and geographies. However, an investment strategy based solely on this indicator is destined to fail.

Companies close to bankruptcy often show low PER precisely because the market distrusts their prospects. Stock market history is filled with examples of companies with seemingly attractive ratios that ended in insolvency.

Smart application of PER requires investing time to examine the company’s operational fundamentals, systematically combining this metric with other relevant financial indicators. Only through this comprehensive approach can one build a truly profitable and sustainable investment portfolio.