PER: The metric every investor must master to evaluate companies

When you look to invest in the stock market, one question always arises: Is this company overvalued or undervalued? The answer often depends on a single figure: the PER. This metric, also known as Price/Earnings Ratio or Price-to-Earnings Ratio, has become the gold standard for comparing companies and making informed investment decisions.

But here’s the catch: most investors know about the PER, but few truly understand what it’s telling us or, more importantly, when it’s misleading us.

What does the PER reveal about a company?

The PER is an indicator that relates the market price of a stock to the profits the company generates. Essentially, it answers a fundamental question: how many times the company’s annual profit represents its total value on the stock exchange?

Imagine a company with a market capitalization of $2.6 billion and net profits of $658 million. Its PER would be approximately 3.95. This means that one year’s profits would only cover 25% of the company’s total market value. Or, in other words, it would take almost 4 years of earnings to pay for the entire company.

The PER is part of the six essential indicators of fundamental analysis: the PER itself, EPS (earnings per share), P/BV (price to book value), EBITDA, ROE, and ROA. While all are important, the PER stands out because it allows us to make quick comparisons between companies and detect valuation patterns.

Calculating the PER: simpler than it seems

Calculating a PER is surprisingly accessible. In fact, you don’t need to be a mathematician to do it. There are two equivalent approaches:

Option 1: At the company level
Divide the total market capitalization by the total net profit.

Option 2: At the share level
Divide the share price by the earnings per share (EPS).

Both formulas give the same result. For example, if a share costs $2.78 and EPS is $0.09, the PER would be 30.9. This means the market is willing to pay 30.9 times the current annual profits for that share.

The necessary data is accessible to anyone. On platforms like Infobolsa (in Spain) or Yahoo! Finance (internationally), they automatically appear under the acronyms PER or P/E along with other key indicators.

Interpreting the PER: what the numbers are telling you

A low PER (between 0 and 10) suggests that the company is undervalued. It sounds tempting, but beware: sometimes it reflects that markets distrust it, possibly due to management issues or sector decline.

A moderate PER (between 10 and 17) is the golden zone for many analysts. It represents companies with expected growth without excessive speculation.

A high PER (between 17 and 25) can indicate two things: either the company has grown significantly since the last earnings report, or markets are anticipating a bright future that might be overly optimistic.

A very high PER (more than 25) enters risky territory. Here we find both companies with spectacular projections and speculative bubbles.

The Meta and Boeing case: two lessons about the PER

Let’s take Meta Platforms (formerly Facebook). For years, its stock rose while the PER systematically decreased, an ideal combination reflecting consistent profit growth. But in late 2022, the trend broke: interest rates rose and tech investors fled, regardless of the PER continuing to fall. The lesson: the PER is not infallible when macroeconomic contexts change.

Boeing presents a different case. Its PER has remained within relatively stable ranges, and the stock price moves in parallel. Here, the indicator works more predictably, though with exceptions depending on aerospace sector cycles.

Advanced variants: Shiller PER and normalized PER

The standard PER has an obvious limitation: it only looks at one year of profits, ignoring the natural volatility of business results.

To correct this, Robert Shiller developed a variant that uses the average profits of the last 10 years adjusted for inflation. The idea is that averaging a decade of results provides a more stable and predictive picture than a single year. According to Shiller, those 10 years of data can even forecast the next 20 years of profits. It’s especially useful in broad economic cycles.

The normalized PER goes further. It adjusts the market capitalization by subtracting liquid assets and adding financial debt. Instead of net profit, it uses free cash flow (FCF). This approach is surgical: it separates the wheat from the chaff and reveals the true financial health. A classic example was the purchase of Banco Popular for 1 euro: although the nominal price was ridiculous, the buyer (Banco Santander) inherited astronomical debt that other competitors rejected.

PER by sectors: don’t compare apples to oranges

A common trap in fundamental analysis is directly comparing companies from different sectors.

Banking and industrial companies typically trade with low PERs, in the range of 2 to 8. ArcelorMittal, the steelmaker, has a PER of 2.58. This doesn’t mean it’s undervalued; it’s simply normal for its sector.

Tech and biotech companies live in a different universe. Zoom Video, driven by the explosion of remote work, hovers around a PER of 202.49. For the tech sector, this is relatively normal. Comparing Zoom with ArcelorMittal using only the PER would be absurd.

That’s why serious investors always compare within the same sector and geography, assuming they operate under similar market conditions.

The PER and the Value Investing strategy

Followers of Value Investing (search for good companies at a fair price) love the PER. Funds like Horos Value Internacional trade with a PER of 7.24, significantly below the average of its category (14.56). Cobas Internacional, another emblem of value investing, also operates with low PERs (5.47 vs. 14 in its category).

For these managers, a low PER in a solid company is exactly the opportunity they seek. The contrast with growth strategies is clear: Growth funds look for companies with high PER but accelerated profit projections.

The limits of the PER: when you shouldn’t rely on it

Despite its usefulness, the PER has significant shortcomings:

It’s inapplicable to unprofitable companies. If a company doesn’t generate profits yet, the PER doesn’t exist or is negative.

It only captures a static moment. Today’s PER tells you nothing about operational problems or management changes coming tomorrow.

In cyclical companies (construction, mining, energy), the PER can be tricky. At the peak of the economic cycle, the PER drops because profits are at their maximum. During a downturn, it rises because profits fall. Investing solely based on PER in these sectors is dangerous.

Combining the PER with other metrics

A serious analysis never relies solely on the PER. It should be integrated with:

• EPS (Earnings per Share): Are profits growing or declining?
• Price/Book Value: What are you paying for each dollar of equity?
• ROE (Return on Equity): What return does the company generate on invested capital?
• ROA (Return on Assets): Efficiency in asset use?
• RoTE (Return on Tangible Equity): Return on tangible equity

Additionally, examine the sources of profits. Are they from core business or one-time asset sales? An inflated profit from a one-off sale is a red flag.

What you should remember

The PER is powerful but not infallible. It’s the fastest tool to compare similar companies but requires context. A low PER on a company on the brink of bankruptcy is still a bad investment. A high PER on a rapidly growing tech company can be justified.

Spend at least 10 minutes delving into financial statements, sector, management, and company prospects. Then, use the PER as an initial signal, not the final truth. This way, you’ll build a solid and profitable investment project.