Ratio PER: the fundamental metric every investor should understand

When it comes to selecting assets to build a solid investment portfolio, there is a metric that stands out above other fundamental analysis tools: the well-known PER. This price-earnings ratio has established itself as one of the most consulted indicators in financial markets, often mentioned together with EPS (Earnings Per Share) in any serious business valuation discussion.

What does PER really represent?

The PER ratio simply but powerfully measures the relationship between what we pay for a company on the stock market and the profits that company generates periodically. The acronym comes from the Anglo-Saxon term Price/Earnings Ratio, which translated into Spanish means simply Price-Benefit Ratio.

Let’s imagine a company with a market capitalization of 1,500 million euros and an annual profit of 100 million euros. A PER of 15 would tell us that, with the company’s current profits, it would take 15 years to recover what we paid for it in the stock markets.

This indicator is part of what we could call the basic toolkit of fundamental analysis, sharing prominence with other metrics such as EPS, the Price/Book Value ratio, EBITDA, ROE, and ROA. But the reason PER stands out is because it offers us a mental shortcut: when market capitalization exceeds profits, we need more years to recover our investment; when capitalization is small compared to generated profits, recovery would be faster.

PER formulas: two ways to reach the same result

There are two equivalent approaches to calculating this ratio that yield identical results:

First approach - Using global figures: Divide the company’s market capitalization (its total value on the stock exchange) by the net profit generated over the last year.

Second approach - Using per-share data: Take the current share price and divide it by the earnings per share (EPS).

Both formulas are immediately accessible to any investor. You don’t need complex tools; the data is available on any financial portal. Whether you look for information on Spanish platforms under the acronym “PER” or on Anglo-Saxon websites where it appears as “P/E,” it is the same indicator.

Where to find this metric and how to interpret it?

Specialized financial portals always display PER alongside complementary data such as market capitalization, EPS, or the 52-week price range. It is such readily available information that it’s almost surprising how many investors ignore or misinterpret it.

However, interpreting PER requires some context:

A low PER (between 0 and 10) suggests that the company might be undervalued, making it a potential buy candidate. However, caution is needed: a low PER can also indicate that investors anticipate a future profit decline or that the company faces operational difficulties.

A moderate PER (between 10 and 17) is generally considered optimal by analysts. It indicates that the company is growing at an expected pace without signs of immediate overvaluation.

A high PER (between 17 and 25 or higher) can mean two very different things: that the market has huge expectations for future growth, or that we are in a speculative bubble. Context is crucial here.

Specialized variants of PER: Shiller and normalized

The standard PER has generated derivatives that attempt to correct its limitations. The Shiller PER extends the time horizon, using the average profits of the last 10 years adjusted for inflation. The logic is that using only one year’s profit is too short and subject to volatility; a decade provides a more robust view.

The normalized PER, on the other hand, refines the calculation by including financial debt and considering free cash flow instead of net profit. This approach is especially valuable in cases like acquisitions where hidden liabilities exist. For example, when Santander bought Banco Popular for “one euro,” it was actually assuming billions in debt, making the real price very different.

Sector context: a determining factor in interpretation

This is one of the main pitfalls of PER analysis. Companies in different sectors will naturally have very different multiples.

Banking sector companies tend to operate with low PERs, typically between 4 and 8. Similarly, industrial and steel companies maintain conservative ratios. ArcelorMittal, dedicated to steel production, operated with a PER around 2.5 during normal periods.

In contrast, the technology and biotech sectors navigate in completely different waters. Companies like Zoom reached PERs over 200 during their boom, reflecting exponential growth expectations that the market attributed to them.

This difference is not a flaw but a reflection of reality: a bank generating stable and predictable profits does not deserve the same multiple as a fast-growing tech startup with higher risks.

PER behavior in practice: real cases

Observing how a company’s PER evolves is instructive. Meta Platforms (formerly Facebook) exemplifies the ideal case: for years, its PER steadily decreased while the stock price rose. This indicated that profits were growing faster than valuation, an ideal scenario for shareholders.

However, from late 2022 onwards, this relationship broke down. Meta’s shares fell even when PER hit historic lows because the market was anticipating a future profit decline driven by changes in privacy policies and lower advertising expenses.

Boeing shows another pattern: its PER remains relatively stable within a range, and the stock tends to rise or fall in sync. The significant point here is that the sign of the result (positive or negative) defines the behavior more than its magnitude.

Practical advantages of PER

The main appeal of PER lies in its operational simplicity. It requires no complex calculations; it is transparent and replicable. Additionally, it allows quick comparisons between competing companies within the same sector, which is invaluable in stock selection.

Another benefit: it works even for companies that do not pay dividends. Many ratios become useless in such cases, but PER retains its usefulness.

It is understandable why it ranks among the top three metrics consulted by investment professionals worldwide.

Limitations we cannot ignore

But PER has structural deficiencies. It uses only one year’s profits to project the future, ignoring longer economic cycles. An industrial company at the peak of its cycle will have an artificially low PER; during the downturn, PER spikes, even if nothing fundamental has changed in the company.

It is not applicable to companies without profits, which excludes startups and loss-making companies, common especially in high-growth sectors.

It provides a static view of the company, capturing a moment in time without considering management dynamics or imminent business changes.

Integrating PER into an investment strategy

Investors practicing “value investing” — seeking quality companies at affordable prices — rely heavily on PER. Funds like Horos Value Internacional or Cobas Internacional operate with multiples below the average of their category precisely because their philosophy is to identify undervalued companies.

However, an investment based solely on finding the lowest PER is naive. The market’s history is full of companies with low PERs that ended up bankrupt. That low multiple was the market correctly valuing a declining business.

The correct approach combines PER with other metrics: EPS, ROE (Return on Equity), ROA (Return on Assets), the Price/Book Value ratio. Additionally, it is essential to conduct a detailed analysis of how those profits are generated. Do they come from operational business or one-time asset sales? Is the company in an industry with favorable or unfavorable winds?

Ten minutes investigating a company’s results composition is worth more than a mechanical search for low ratios.

Final reflection: tool, not a magic wand

PER is an excellent tool for comparative analysis within a specific sector and geography. When two companies compete in similar markets under comparable conditions, their relative multiples tell us something meaningful about relative valuation.

But PER should never be the only metric in your investment process. Low multiples can reflect failed businesses. High multiples can be justified by explosive growth or irrational exuberance.

What distinguishes a competent investor is precisely their ability to combine this indicator with other data, sector context, trend analysis, and business quality assessment. With that comprehensive approach, PER becomes what it should be: a valuable piece in the puzzle of fundamental analysis.