Understand the PER: concept, calculation, and usefulness in investment selection

The PER ratio is one of the most consulted indicators by investors and analysts when evaluating a company’s potential. This article will provide you with a comprehensive guide on how this ratio works, its correct interpretation, and the limitations to consider when using it in your fundamental analysis.

Understanding the PER ratio: definition and scope

The PER ratio measures the relationship between a stock’s market price and the periodic earnings generated by the company. Its initials stand for Price/Earnings Ratio, or in Spanish, Ratio Precio/Beneficio.

This indicator allows you to understand how many times the company’s market capitalization is reflected in its annual profits. Put another way: if a company has a PER of 15, it means that its current profits (projected over 12 months) would take 15 years to pay off the total value of the company on the stock market.

Among the 6 fundamental ratios in company analysis, the PER, EPS (Earnings Per Share), P/VC, EBITDA, ROE, and ROA stand out. Although each offers different perspectives, the PER holds a privileged position in any serious investment evaluation, especially when comparing companies within the same sector.

How the PER ratio works in different market contexts

The dynamics of the PER ratio reveal interesting patterns in stock behavior. In some cases, we observe that when the PER decreases while the stock price rises, the company is generating more profits without necessarily being proportionally valued by the market. This was the typical scenario for Meta Platforms in previous years: profit after profit, with an increasingly attractive price-earnings ratio.

However, other macroeconomic factors can disrupt this correlation. For example, when central banks raise interest rates, technology stocks often fall in price even if their PER ratios improve, because the market adjusts its expectations about future performance.

In more cyclical sectors, such as aerospace, the PER ratio can remain stable within a range while the stock fluctuates significantly. What usually determines this is the sign of the result: whether the company remains profitable or has entered into losses.

Procedure to calculate the PER ratio

The calculation of this ratio can be done in two equivalent ways:

Method 1 - Using aggregate figures: Market Capitalization ÷ Net Profit = PER

Method 2 - Using per-share values: Share Price ÷ Earnings per Share (EPS) = PER

Both formulas yield identical results and require data that are readily available on any financial platform.

Where to find the PER ratio

The ratio systematically appears in any financial publication covering asset information. Depending on your geographic origin, it may be found under the initials “PER” (most common terminology in Spain) or “P/E” (the predominant nomenclature in US and UK platforms like Yahoo Finance). Alongside the PER, other data such as market capitalization, EPS, 52-week range, and total number of shares outstanding typically appear.

Practical calculation examples

Case 1: A company with a market capitalization of $2.6 billion and net profits of $658 million has a PER of 3.95.

Case 2: A company whose shares trade at $2.78 with EPS of $0.09 has a PER of 30.9.

Variants of the PER: beyond the basic calculation

Shiller PER: a long-term perspective

The traditional PER is criticized for using only one year’s profits, a period that can be excessively volatile. The Shiller PER addresses this limitation by taking the average profits of the last 10 years adjusted for inflation, divided by the current market capitalization.

This methodology aims to project profits over the next 20 years on a more solid and representative basis, thus reducing noise caused by short-term anomalies in results.

Normalized PER: adjustment for financial structure

This variant corrects distortions caused by capital structure. Instead of using net profits, it employs Free Cash Flow, and adjusts the capitalization by subtracting liquid assets and adding financial debt.

This approach is especially useful in complex transactions. When an entity acquires another by assuming millions in debt, the normalized PER more faithfully reflects the economic reality than a traditional PER.

The usefulness of the PER in investment strategy

The PER ratio allows for quick identification of whether a company is overvalued or undervalued compared to its peers in the same sector. An excessively high PER suggests that the company is trading at levels that do not match its current profit generation. Conversely, a low PER may indicate a buying opportunity, although it could also point to underlying management problems.

Interpretative ranges of the PER

The PER and Value Investing: searching for undervalued gems

Value investors heavily use the PER to identify quality companies at good prices. Benchmark funds like Horos Value Internacional maintain PER ratios significantly below their category (7.24 versus 14.55), demonstrating how the Value methodology materializes in practical portfolios.

Crucial limitations of the PER

Sectoral differences are decisive

PER cannot be interpreted uniformly across sectors. Banking and industrial companies typically have low PERs (ArcelorMittal around 2.58 in metallurgy), while the technology and biotech sectors show extraordinarily high ratios (Zoom Video once exceeded 202).

This disparity reflects completely different business structures: industry generates predictable profits with moderate margins, while technology promises exponential growth justifying higher price multiples.

Inherent deficiencies of the ratio

• Static perspective: reflects a specific moment, not the company’s dynamic trajectory
• Inapplicable to losses: does not work with companies that do not generate profits
• Volatility sensitivity: especially problematic in cyclical companies, where a low PER at cycle peaks and high at troughs generate contradictory signals
• Dependence on a single year: extrapolations from one fiscal year can be misleading if extraordinary events occurred

Integrating the PER into a solid fundamental analysis

The PER should never be used in isolation. A comprehensive analysis requires combining this ratio with complementary indicators: EPS, Price/Book Value, ROE, ROA, and RoTE. Additionally, examining the composition of profits is essential. An extraordinarily high profit could result from the one-time sale of a financial asset, not from actual operational performance.

Operational advantages of the PER

• Simple access: public data and straightforward calculation
• Comparability: allows quick assessments between companies in the sector
• Universality: works even with companies that do not pay dividends
• Widespread acceptance: widely consulted by the professional market

Final reflection: the PER as a tool, not a rule

While the PER is a practical indicator for sector comparisons, an investment strategy based solely on it will systematically fail. The stock market history is full of companies with attractive PERs that disappeared due to poor management.

Many near-bankrupt companies maintain low PERs precisely because investor confidence is lacking. Therefore, consider the PER as an initial tool to filter candidates, not as a definitive criterion. Spend 10 minutes analyzing the company’s actual financial structure, its competitive position, and the quality of its management. This effort will turn the PER from an abstract number into a true indicator of opportunity.