PER: The metric every investor must master (and its hidden traps)

When you sit down to analyze a company for investment, there is a number that appears everywhere: the PER. But here comes the real secret: most investors use it incorrectly. This article will take you beyond the basic calculation to show you how to truly interpret this ratio and, more importantly, when to be wary of it.

Why PER has become Wall Street’s favorite

The PER (Price/Earnings Ratio) measures how many times a company’s market capitalization equals its annual earnings. Put simply: it’s the ratio between what it costs to buy a company on the stock market and what it earns in a year.

Imagine a company has a PER of 15. This means that its current profits (projected over 12 months) would take 15 years to “pay off” the total price of the company. It’s such a fundamental indicator that it’s part of the essential ratios alongside EPS (Earnings Per Share), P/VC, EBITDA, ROE, and ROA.

Why is it so important? Because PER goes beyond being a simple comparative number. It allows you to detect whether a company is genuinely growing or just inflating numbers in the short term. Historically, it has been the beacon for investors like Warren Buffett and other disciples of Value Investing.

How to calculate PER (two ways, same result)

The beauty of PER lies in its simplicity. There are two ways to obtain it:

Option 1: Using total company metrics $$\text{PER} = \frac{\text{Market Capitalization}}{\text{Total Net Profit}}$$

Option 2: Using per-share data $$\text{PER} = \frac{\text{Share Price}}{\text{EPS (Earnings Per Share)}}$$

Both formulas yield the same result. The important thing is that the data is accessible to anyone: on financial platforms like Yahoo Finance (where you’ll see “P/E” on English-language websites) or Infobolsa (where it appears directly as PER).

Let’s look at two practical examples:

Example A: A company with a market cap of 2.6 billion dollars and annual profits of 658 million. $$\text{PER} = \frac{2,600}{658} \approx 3.95$$

Example B: A stock at $2.78 with EPS of $0.09. $$\text{PER} = \frac{2.78}{0.09} \approx 30.9$$

The difference is enormous. But what does it really mean?

The actual behavior of PER in markets

Theory says that when PER decreases and the stock price rises, we are looking at a company with genuine profit growth. Meta Platforms (Facebook) was the classic example: for years, its PER steadily declined while the stock kept climbing. That indicated they were earning more profits each quarter.

But here’s the trap: reality doesn’t always work that way.

Boeing is an illustrative case. Its PER remains relatively stable within a range, but the stock goes up and down without the ratio changing proportionally. Why? External factors like changes in interest rates, economic cycles, or market risk perceptions that PER doesn’t capture.

Meta experienced this cruelly at the end of 2022. Despite its PER ratios becoming more attractive (decreasing), the stock plummeted. The culprit: Fed rate hikes caused investors to reevaluate the tech sector entirely. PER did not foresee that.

Variants of PER you should know

Not all PERs are the same. There are sophisticated versions many analysts prefer.

Shiller PER: When one year isn’t enough

The classic criticism of PER is that it uses profits from just one year. What if that year was exceptionally good? Or exceptionally bad? The Shiller PER addresses this by using the average profits over the last 10 years, adjusted for inflation.

$$\text{Shiller PER} = \frac{\text{Market Capitalization}}{\text{Average 10-Year Profits (inflation-adjusted)}}$$

The idea is that 10 years of data allow for a more accurate prediction of the next 20 years. However, it has its critics who argue that the last 10 years may not be representative of the future.

Normalized PER: Looking beyond profit

Here, the analysis becomes more surgical. Instead of dividing market cap by net profit, you adjust both sides:

• Numerator: Market capitalization - Net assets + Financial debt
• Denominator: Free Cash Flow (instead of net profit)

Why does this matter? When Santander bought Banco Popular for 1 euro, it wasn’t technically a cheap purchase. They had to assume a colossal debt that forced BBVA and Bankia to withdraw. The normalized PER would have shown that reality.

How to interpret PER (but beware of oversimplification)

There is a common reference table:

But here’s the big secret: This table is almost useless without context.

A low PER isn’t always good news. Companies on the brink of bankruptcy have low PER precisely because investors have lost confidence. Similarly, a high PER in a growing biotech company is completely different from a high PER in a stock forming a bubble.

PER varies dramatically between sectors

This is critical: never compare PERs of companies from different sectors.

ArcelorMittal, a steel producer, has a PER of 2.58. Zoom Video, the platform adopted worldwide during the pandemic, has a PER of 202.49. Which is better? The question makes no sense.

Banks, manufacturing, and energy sectors tend to have low PERs by nature. Tech, biotech, and high-growth companies tend to have high PERs. It’s like comparing apples and oranges. The market expects different profit margins from each sector.

Why Value Investing obsessively focuses on PER

Practitioners of Value Investing (like the Horos Value International fund with PER 7.24 or Cobas Internacional with PER 5.46) seek exactly that: good companies at a good price.

A low PER is their buy signal. But they are disciplined: they verify that the low PER isn’t due to poor management but a temporary market opportunity. That’s the difference between investors who lose money in “value traps” and those who build wealth.

Limitations nobody wants to admit

PER has serious shortcomings:

1. Uses only one year of data to project the future, ignoring economic cycles
2. Inapplicable to companies without profits (startups, pre-profit companies)
3. Static, not dynamic - it doesn’t capture management trajectory or market changes
4. Fails with cyclical companies - at the cycle peak, PER looks attractive; at the trough, it looks terrible

The winning combination: PER + other metrics

If you base all your decisions solely on PER, you will fail. Professional investors always cross PER with:

• EPS: To see profit growth per share
• Price/Book Value (P/VC): To detect if there’s real net value
• ROE and ROA: To measure operational efficiency
• Free Cash Flow: To verify that profits are real (not just accounting)

Additionally, it requires in-depth analysis of the business composition. Does that high profit come from the core business or an isolated asset sale? The answer changes everything.

What truly matters: an integrated perspective

PER is an excellent tool for an initial screening of companies within the same sector and geography. It’s easy to calculate, widely available, and efficient for quick comparisons.

But it’s never enough. The history is full of companies with attractive PERs that collapsed because management was poor, the sector declined, or numbers were cosmetic.

A winning investment requires: dedicating time to truly understand the company, combining multiple metrics, considering sectoral and macroeconomic context, and recognizing that even with all this data, the future always holds surprises.

PER is your starting point. But it should never be your endpoint.