Deciphering the PER: The Fundamental Metric Every Investor Must Master

When we talk about selecting companies to invest in, there is a metric that is essential in any analysis: the P/E ratio. This relationship allows us to evaluate whether a company is truly worth what the market is paying for it. Unlike other indicators, the P/E combines two key elements: the stock price and the ability to generate profits.

Understanding what the P/E is and its relevance in the market

The P/E represents the ratio between the price at which a company’s shares are traded and the profits it generates. Its initials come from the English term “Price/Earnings Ratio,” although in our language it is known as “Price/Earnings Ratio.”

This indicator is part of what is called fundamental analysis, along with other essential metrics such as EPS (Earnings Per Share), P/BV (Price/Book Value), EBITDA, ROE (Return on Equity), and ROA (Return on Assets). Together, these six ratios form the basic arsenal for any serious investor.

Essentially, the P/E tells us how many years it would take for a company’s current profits to pay for its current market valuation. Imagine a company with a P/E of 15: this means that, extrapolating its earnings over 12 months, it would take 15 years of those earnings to match the company’s total market value.

The practical: How exactly is the P/E calculated

The P/E formula is accessible to anyone with basic math skills. There are two valid approaches to obtain it:

First method - Using aggregate figures: Divide the company’s market capitalization by its total net profit. If a company has a market cap of 2.6 billion dollars and net profits of 658 million, its P/E would be approximately 3.95.

Second method - Using per-share data: Take the unit price of each share and divide it by the EPS (Earnings Per Share). If the price is $2.78 per share and EPS is $0.09, the result would be a P/E of 30.9.

Both systems yield equivalent conclusions. The interesting part is that the necessary data are publicly available on any financial platform, allowing anyone interested to perform these calculations independently.

Where to find the P/E in your analysis tools

Practically all financial data platforms display this ratio routinely. Depending on your geographic region, you may find it under two names: in Spanish, it often appears as “P/E,” while on North American and British portals, the acronym “P/E” is used.

Alongside the P/E, these platforms also provide market capitalization, EPS, 52-week ranges, and the total number of shares outstanding. Having access to this complete context significantly facilitates decision-making.

Interpreting the P/E: Ranges and their meanings

Not all P/E values mean the same. Its interpretation depends on sector context, business health, and growth prospects:

• P/E between 0 and 10: Indicates the company is cheap, although this cheapness may hide future profitability problems. Further investigation is needed.

• P/E between 10 and 17: Considered the “comfort zone” by professional analysts, suggesting a balanced valuation with moderate growth potential.

• P/E between 17 and 25: An ambiguous territory where there may be both real company growth and signs of early overvaluation.

• P/E above 25: Here, two scenarios coexist: either projections about the company are extraordinarily positive, or we are approaching a speculative bubble.

It is fundamental to understand that these ranges are indicative. A mechanical interpretation of the P/E without considering other factors is one of the most costly mistakes in investing.

The risk of relying solely on the P/E

Many novice investors make the mistake of reducing their entire strategy to this indicator. The reality is more complex. The market often undervalues companies for extended periods, but if you observe a company with a consistently low P/E, it is probably because its management is poor and bankruptcy looms.

For example, at the end of 2022, Facebook (Meta) experienced price drops despite showing increasingly lower P/E ratios. The reason: interest rate hikes by the Federal Reserve changed expectations about tech stocks, regardless of the P/E.

Cyclical companies have particularities. At the peak of the economic cycle, their P/E appears low; during contraction, it skyrockets. This makes using the P/E as the sole criterion misleading.

Variants of the P/E: Shiller P/E and Normalized P/E

The Shiller P/E emerges as an alternative to the conventional P/E. Its main innovation is temporal: instead of considering only one year’s profits, it uses the average profits of the last 10 years, adjusted for inflation. The premise is that observing a decade provides a more robust view and that this historical data allows projecting the next 20 years.

The Normalized P/E adopts another approach. It adjusts the market capitalization by subtracting liquid assets and incorporating financial debt. In the numerator, instead of net profit, it uses Free Cash Flow (Free Cash Flow). This refinement is particularly useful in complex situations: when Banco Santander acquired Banco Popular for 1 euro, it actually assumed a colossal debt that completely transformed the valuation equation.

P/E by sector: Why comparison must be intelligent

A valid comparison always requires that companies belong to the same sector. This is not a methodological whim but an analytical necessity.

Banks and manufacturing industries typically maintain low P/E ratios. ArcelorMittal, a steel producer, has a P/E close to 2.58. Conversely, technology or biotech companies reach stratospheric multiples. Zoom Video, popularized during the pandemic, reached a P/E of 202.49.

This disparity does not mean Zoom is overvalued nor that ArcelorMittal is a bargain. It simply reflects different sector dynamics, growth prospects, and profitability structures inherent to each industry.

Combining the P/E with other analysis tools

True analytical power emerges when the P/E is integrated with other ratios. EPS is an obvious complement, but it is also advisable to examine Price/Book Value, ROE, ROA, and RoTE.

Equally important is conducting a thorough analysis of the business components. Sometimes profit appears high not due to normal operations but because of one-off sales of financial assets. Without this deep dive, the P/E can be misleading.

Value Investing funds, such as Horos Value Internacional or Cobas Internacional, demonstrate this practice. Their portfolios show P/E ratios significantly below the average of their category precisely because they combine the P/E with robust qualitative analysis.

Practical advantages of the P/E for investors

• Accessibility: Its calculation is simple, and data are publicly available for listed companies.
• Efficient comparison: Allows quick comparison between companies in the same sector.
• Versatility: Works even with companies that do not pay dividends, a limitation affecting other indicators.
• Universal reference: Part of the basic toolkit for investors and professional analysts worldwide.

Limitations that cannot be ignored

• Short-term horizon: Relying on profits from just one year is problematic when business reality is more dynamic.
• Inoperative with losses: The P/E does not exist for companies without positive profitability.
• Static snapshot: Reflects a moment, not the company’s actual dynamic trajectory.
• Cyclical difficulty: Companies in different economic cycles show misleading P/E ratios.

Value Investing and its relationship with the P/E

Practitioners of Value Investing understand that investing means “finding good companies at a good price.” The P/E is their primary compass. Value funds typically maintain P/E ratios well below their growth peers, reflecting a philosophy that prioritizes solidity over speculation.

Final reflection: P/E as a tool, not an absolute truth

The P/E is unquestionably valuable for fundamental analysis. It stands out for its simplicity, accessibility, and comparative usefulness among companies in the same sector and geography, operating under similar market conditions.

However, an investment strategy that relies solely on the P/E is doomed to failure. The financial history is full of companies with attractive P/E ratios that disappeared from the map. The difference between a mediocre investment and a profitable one lies in intelligently combining the P/E with deep sector analysis, management evaluation, macroeconomic context, and other complementary metrics. Invest time in truly understanding the company before deciding, and you will build a robust and genuinely profitable portfolio.