The calculation of the PER is simple enough — it is the share price divided by earnings (historical or forecast) — and can be done quickly, which we think is the biggest part of its appeal. It is also easy to communicate — it basically tells how many times you are paying for each dollar of the company’s earnings or profit. And one could determine whether the stock is cheap (undervalued) or expensive (overvalued), either on its own by comparing to its historical PER or relative to other stocks and the broader market — at least that is what the financial journalists, market commentators and analysts will tell you. They would be wrong.
It seems ironic that one of the most universally known valuation metrics, the priceto-earnings ratio (PER), which is widely used for its “simplicity”, is still so misunderstood by many, not just the man in the street but also seasoned financial journalists, analysts and fund managers, even those on CNBC.
PER = Market price per share / Earnings per share (EPS)
