How PER defines your stock investment decisions

When faced with choosing between different stocks to invest in, there is an indicator that constantly appears on any trader’s screens: the PER (Price/Earnings Ratio or Price/Earnings Ratio). Although many investors check it automatically, few truly understand what it means, how it is calculated, and, more importantly, how to interpret it correctly without falling into costly errors.

The PER is, in essence, a mirror that reflects the relationship between what you pay for a stock and the actual profits the company generates. If you know how to read it, you’ll have a powerful tool; if you ignore it, you could lose money in companies that seem cheap but are headed for disaster.

From theory to practice: What does the PER really tell us?

The PER indicates how many years it would take for a company’s current profits to “pay off” its total market value. Imagine a company has a PER of 15: its current (projected over 12 months) profits would need 15 years to cover what it is worth in the market today.

This concept seems simple, but its interpretation is where most investors go wrong. A low PER doesn’t always mean you’ve found a bargain; sometimes, it indicates that the market has lost confidence in the company for good reasons.

Let’s consider Meta (Facebook): a few years ago, while the stock was steadily rising, its PER was decreasing simultaneously. This was positive: the company was earning more profits each quarter, justifying the price increase. However, since late 2022, we observe a dramatic break: the PER remains low, but the stock falls. The cause? Changes in monetary policy and expectations about tech stocks altered market sentiment, regardless of the numbers.

Boeing presents a different example: its PER fluctuates within consistent ranges while the stock experiences volatility. Here, what is truly significant is whether the profit is positive or negative, not necessarily the absolute value of the ratio.

The two ways to calculate the PER

Although the concept is singular, there are two paths to reach the same destination. Both yield identical results, but one may be more practical depending on the situation.

First formula (company level): Market Capitalization ÷ Total Net Profit = PER

Second formula (stock level): Stock Price ÷ Earnings Per Share (EPS) = PER

Let’s take two practical examples:

In the first case, if a company has a market capitalization of 2.6 billion dollars and net profits of 658 million, its PER would be 3.95. This result suggests a very cheap company, although it could also indicate that the market distrusts its sustainability.

In the second case, with a stock trading at $2.78 and an EPS of $0.09, we get a PER of 30.9. This radical difference shows how the same concept can produce completely different interpretations depending on the company’s size.

Where to find this metric and how to look for it

Locating it is simple. In practically any financial platform you consult — from European providers like Infobolsa to American ones like Yahoo! Finance — you’ll see the PER along with data such as market capitalization, EPS, 52-week range, and shares outstanding.

It is important to note that some platforms call it “PER” while others use “P/E,” especially in Anglo-Saxon markets. The meaning is identical; only the notation varies depending on the region.

Variants of the PER: beyond the basics

The traditional PER has recognized limitations, so analysts have developed variants to address them.

The Shiller PER is perhaps the most well-known. Instead of using profits from a single year (which can be volatile), it takes the average profits of the last 10 years, adjusted for inflation. The theory holds that this decade-long perspective allows for a more accurate forecast of profits over the next 20 years. Its supporters argue it provides a truer picture of business reality; critics counter that looking backward does not guarantee anything about the future.

The normalized PER addresses another problem: not all profits reflect the company’s actual operations. This indicator adjusts the market capitalization by subtracting liquid assets and adding financial debt, while in the denominator it uses Free Cash Flow instead of net profit. The case of Banco Santander acquiring Banco Popular for “1 euro” illustrates this perfectly: that apparent price concealed enormous debt that other entities could not assume.

Interpreting the PER according to context

Here’s the critical part: there is no “perfect PER” that works for all companies and sectors.

Traditional interpretation suggests:

• 0-10: Attractive, but potentially problematic (why is it so cheap?)
• 10-17: The preferred zone for analysts, with expectations of moderate growth
• 17-25: Sign of significant growth or possible overvaluation
• 25+: Two extremes: very positive projections or a bubble forming

But this guide collapses when comparing sectors. ArcelorMittal, dedicated to metallurgy, has a PER of 2.58. Zoom Video, the videoconferencing company, reaches 202.49. Which is “correct”? Both, in their contexts: industry typically maintains low ratios, while technology and biotechnology operate in significantly higher ranges.

The PER as a tool for Value Investing

Value investors base much of their strategy on this indicator. Their philosophy is clear: seek good companies at a good price. Funds like Horos Value Internacional (PER 7.24 versus a category of 14.56) or Cobas Internacional (PER 5.46) demonstrate how managers select companies trading systematically below their peers, hoping the market will eventually recognize their value.

The real limitations you cannot ignore

The PER shines when comparing similar companies within the same sector but has significant vulnerabilities:

It is temporarily shortsighted: It only looks at one year’s profits, ignoring long-term trends. A company with abnormally high profits this year could face dramatic declines next year.

Fails with unprofitable companies: If a company is not yet profitable, the indicator simply doesn’t work. Many emerging tech firms fall into this category.

Deceives with cyclical companies: During the peak of the economic cycle, its PER will be artificially low; during downturns, it skyrockets. This completely reverses the “low = good” logic.

Reflects the past, not the future: It is a static snapshot of the moment, not a prediction of the company’s future behavior.

Combining the PER with other signals

An investment based solely on PER is doomed to failure. Many bankrupt companies have low PER precisely because no one trusts them. You need to complement it with:

• EPS (Earnings Per Share): To understand profit quality
• Price/Book Value: To evaluate real assets
• ROE (Return on Equity): To measure efficiency
• ROA (Return on Assets): To assess total return
• Free Cash Flow: To confirm that profits are real, not just accounting figures

Additionally, spend time understanding the composition of profit. Does it come from core business or a one-time sale of assets? This is where the difference between a solid company and one that manipulates its numbers lies.

Undeniable strengths of the PER

Despite its limitations, it remains a useful tool because:

• It is accessible: Anyone can calculate it in seconds
• Allows quick comparisons: Among companies in the same sector, it works effectively
• It is universal: Even companies without dividends can be compared
• Professionals use it: It remains one of the three most consulted basic metrics

Conclusion: Use it, but intelligently

The PER in the stock market is like a compass: useful for orientation but insufficient if you want to cross a mountain. A company with a low PER trading consistently could be a bargain or a trap; only in-depth analysis will reveal which.

If you want to build a profitable portfolio, combine the PER with other metrics, study the sector, understand the company’s true financial health, and remember that past numbers never guarantee future results. Successful investing requires patience, diligence, and above all, humility in the face of market complexity.