How to interpret the PER: the metric every investor must master

Fundamental analysis of a company requires mastering several key indicators. Among them, the P/E ratio stands out as one of the most consulted by investment professionals. This metric, whose initials stand for Price/Earnings Ratio, provides a direct reading on whether a company is overvalued or undervalued in the stock market.

The P/E Ratio: definition and usefulness in the stock market

When we talk about the P/E ratio, we refer to the indicator that measures the relationship between the current stock price of a share and the net earnings the company generates periodically. In practical terms, the P/E answers this question: how many years of current earnings would be needed to recover the initial investment?

This indicator is part of the set of six essential metrics to evaluate an organization’s health: the P/E ratio, EPS (earnings per share), P/BV (price to book value), EBITDA, ROE, and ROA.

A P/E of 15, for example, means that the company’s annual earnings (projected over 12 months) would take 15 years to match its current market capitalization. This simple reading allows investors to make quick comparisons between companies in the same sector.

Calculating the P/E ratio: two equivalent methods

The calculation is straightforward and accessible. There are two approaches that produce identical results:

Method 1 - Global magnitudes:

• P/E = Market capitalization / Net profit

Method 2 - Per share:

• P/E = Share price / Earnings per share (EPS)

Let’s look at two practical examples:

Case A: A company with a market capitalization of 2,600 million dollars and net earnings of 658 million would have a P/E of 3.95.

Case B: If a share trades at $2.78 with an EPS of $0.09, the P/E would be 30.9.

The difference between the two results reflects companies with very different profiles: the first undervalued, the second potentially expensive.

Where to find this metric?

Any financial data platform presents the P/E ratio immediately. It appears alongside market capitalization, EPS, 52-week ranges, and the number of shares outstanding. Depending on the region, you’ll find the data under the initials P/E (in Spain and Ibero-America) or P/E (on English portals like Yahoo! Finance).

The P/E ratio by sector: contextualized readings

A common mistake is comparing companies from different industries using only the P/E ratio. The characteristics of each sector produce significant disparities:

• Traditional industries (banking, metallurgy): low P/E, typically between 2 and 8
• Technology and biotechnology: high P/E, often between 50 and 200

ArcelorMittal, in metallurgy, maintains a P/E close to 2.58, while tech companies can reach values of 200 or higher. These differences respond to growth expectations: the market pays more for future benefits potentially greater in tech than in mature industries.

Standard interpretation of the P/E ratio

The most used reference table is:

However, this interpretation should be nuanced. A low P/E is not always positive: declining companies often trade at depressed P/E because the market distrusts their future profit-generating capacity.

Variants of the P/E for deeper analysis

Shiller P/E

This variant uses a 10-year period instead of just one. It divides the market capitalization by the average profits of the last decade, adjusted for inflation. The theory suggests that this ten-year horizon allows for more accurate projections of benefits over the next 20 years.

Normalized P/E

Adjusts the metric to better reflect financial health. The numerator takes market capitalization, subtracts liquid assets, and adds debt. The denominator uses free cash flow instead of net profit. This method “peels the onion” of the financial statement.

The case of Banco Santander acquiring Banco Popular for 1 euro exemplifies why this matters: although the nominal price was one euro, the assumed debt completely transformed the actual operation.

P/E and Value Investing: the pursuit of gains

Investment strategies based on Value Investing heavily depend on the P/E ratio. This approach seeks “good companies at a good price,” and the P/E provides a quick initial filter. International Value funds typically trade at P/E ratios significantly below the average of their category, reflecting their philosophy of selective buying at depressed prices.

Combining with other indicators

The P/E ratio should never be used in isolation. A robust analysis incorporates:

• EPS: Complements the P/E by showing earnings per unit of capital
• Price/Book Value: Offers perspective on assets vs. market value
• ROE and ROA: Show operational and asset efficiency
• Profit composition analysis: Checks whether profits come from core business or one-time asset sales

Combining multiple indicators prevents decisions based on superficial metrics.

Strengths of the P/E indicator

• Simple calculation accessible to any investor
• Quick and clear comparison between companies in the same sector
• Applicable even in companies without dividend policies
• Foundation for decision-making by most professional analysts
• Immediate availability on all platforms

Limitations to consider

• Only considers profits from one fiscal year for future projections
• Not applicable in companies with negative earnings
• Static, not dynamic, reflection of current reality
• Problematic in cyclical companies: low P/E at cycle peaks, high P/E at troughs
• Ignores qualitative factors like management, competitive positioning, and trends

Final reflection

The P/E ratio is a practical and efficient tool for comparative analysis within the same geographic sector. Its value lies in simplicity, not in being the sole decision metric.

An investment strategy based solely on low P/E will systematically fail. Many companies on the brink of bankruptcy show depressed P/E not because they are gains, but because the market has lost confidence in them. Stock market history is full of examples of companies with seemingly attractive P/E ratios that eventually disappeared.

A balanced approach dedicates time to understanding the company’s core, combines the P/E with complementary indicators, and considers sector context before executing any decision. Only then does fundamental analysis become a solid foundation for sustainable profitability.