Valuation indicators (2/9)

The price/earnings ratio

Among the many financial indicators, the "PER" (Price/Earnings Ratio) remains incontestably one of the most scrutinized by the investment community. This fundamental indicator puts the stock price of a share into perspective in relation to the annual net profits per share generated by the company.

The acquisition of shares in companies with a modest PER is proving to be an effective investment strategy. However, according to some financial authors such as James O'Shaugnessy, its application is limited essentially to large companies. This restriction is explained in particular by the fact that profits can be subject to more or less sophisticated accounting manipulations. This risk is all the more significant for small companies, which are generally subject to a less rigorous level of monitoring and auditing.

Even large companies can present misleading earnings if one does not pay close attention to the detailed annotations in their financial reports. Exceptional items, whether positive or negative, can significantly bias this performance indicator. Furthermore, the methodologies for calculating earnings per share vary from company to company: some include exceptional events in their calculations, while others exclude them. In my financial analysis practice, I systematically favor the calculation of the Price Earning Ratio by focusing only on recurring results, thus excluding items that are not representative of the company's normal activity.

It is also worth taking into consideration the volatility inherent in corporate profits. It is well known in finance that successful companies today can experience reversals of fortune tomorrow (and vice versa). This unpredictability makes any reliable projection of a company's future results particularly complex, especially since the Price Earning Ratio indicator only reflects historical performance, with no guarantee of future prospects.

It is clear that the PER has many limitations. However, it has the undeniable advantage of being easily consultable on the majority of financial platforms. Although it is a relevant basic indicator for initiating a financial analysis, it cannot be considered a sufficient evaluation criterion on its own. A more in-depth analysis, integrating other financial ratios and indicators, is essential for a complete and reliable evaluation.

 

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