Practical PER Guide: How Investors Use It to Detect Opportunities

When faced with the decision to invest in a company, there is one indicator that virtually all analysts consult without exception: the P/E ratio. This metric, accompanied by EPS (Earnings Per Share), is essential in any serious fundamental analysis. But why does it attract so much attention? Because it allows us to see whether a company is truly expensive or cheap relative to what it earns.

What exactly is the P/E ratio and why does it matter?

The P/E — whose initials stand for Price/Earnings Ratio — is simply the quotient between a stock’s market price and the profits it generates periodically. In other words: it tells us how many years it would take for a company’s current earnings to equal its total market value.

Imagine a company with a P/E of 15. This means that, maintaining its current earnings constant, it would take 15 years of profits to match what the entire company costs today. It’s an elegant way to answer the question: am I paying too much or too little for this investment?

The P/E belongs to the group of the 6 fundamental ratios that every analyst should master:

• The P/E itself
• The EPS (Earnings Per Share)
• The P/BV (Price/Book Value)
• The EBITDA
• The ROE (Return on Equity)
• The ROA (Return on Assets)

What’s interesting is that the P/E fluctuates constantly. Meta Platforms (Facebook) is an illustrative case: for years, its P/E decreased gradually while the stock price rose. The reason? Because the company was multiplying its profits year after year. This is precisely what investors want to see: a company that grows earnings while its valuation (relatively) becomes cheaper.

However, since the end of 2022, this pattern was broken. Facebook fell in the stock market even though its P/E continued to decline. Why? The increase in interest rates by the Fed made tech stocks generally less attractive, regardless of their P/E.

Practical formulas to calculate the P/E ratio

The calculation is so simple that anyone can do it. There are two approaches that give identical results:

Option 1 — At the company level: