In this blog post, we explore the true meaning of PER—a concept many investors easily misunderstand—and the fundamental nature of stock price determination.

Why do stock prices fluctuate?

Many investors feel confused when faced with this question. Especially for those just starting out, the seemingly unpredictable movements of stock prices can feel like a random game driven by intuition. However, stock prices follow their own ‘logic’. It’s just that this logic operates on a slightly different structure than the common sense or number-centric calculations we might expect, which can lead to misunderstandings.

When I first stepped into the stock market

I’m a ‘newbie investor’ with an engineering background who hasn’t been trading stocks for very long. I had almost no financial knowledge and thought stocks were just a speculative realm chasing returns. Then, late last year, when rumors like “Now’s the time!” and “Someone’s profits jumped 200%!” were swirling around me, I took my first step into the stock market.
Given my personality, which values rational thinking, I decided to trust data over gut feelings or rumors. I meticulously analyzed financial indicators like each company’s financial statements, operating performance, price-to-earnings ratio (PER), and price-to-book ratio (PBR) to select promising stocks. The stocks I ultimately bought all maintained stable financial health, and one company even announced an expected growth rate of 30%. I felt I’d made quite a rational choice.

But… I got hit hard.

However, right after the 2021 Lunar New Year holiday, the situation changed dramatically.
The stocks I had trusted and bought began to plummet one after another. There were no particular adverse factors in their management, and their earnings reports were favorable, yet their stock prices fell relentlessly. The market turned on me fiercely, and my account instantly went from red to blue.
What was even more perplexing was that stocks of companies with poor performance, or even those posting losses, were actually rising. Tesla was a prime example. At the time, Tesla’s P/E ratio was over 1,000 times. I even thought, ‘With this profit structure, wouldn’t it take a thousand years to break even?’ Where exactly was the logic in this market?

Earnings don’t determine stock prices

The 2020 stock market was literally a ‘frenzy’. Since most stocks were on an upward trend, it seemed like buying any stock would yield profits. Various investment methods and rumors intermingled, creating a chaotic market environment. However, entering 2021, the market gradually began to lose its balance. Even ‘blue-chip stocks’ with excellent performance and solid assets plummeted, throwing many investors into confusion. From this period, many began to wonder:

‘If the analysis methods I’ve learned so far don’t work, what principle is driving the stock market?’

Many investors still try to judge stock prices based on the price-to-earnings ratio (PER). However, there is a crucial misunderstanding here. PER is not an indicator that determines stock prices; it is an indicator that appears after the stock price has been determined. PER is merely a tool that expresses whether “the current stock price of this company is expensive or cheap relative to its earnings.” It is not a direct determinant of the stock price.

PER and PBR are merely ‘results’

PER and PBR (Price-to-Book Ratio) are not just simple numbers.
For example, if a company’s PBR is below 1, it means the market values that company at less than its actual assets. Theoretically, selling off all assets and liquidating could yield a higher profit. To use a car analogy, it’s like selling a new car for less than the cost of its parts. While this sounds absurd, it actually happens in the stock market.
This phenomenon is evidence that stock prices are determined by factors more complex than just profits or assets.
So what exactly drives stock prices?

Stock prices are the sum of ‘future expectations’

Stock prices reflect the ‘expectations of market participants’.
More precisely, they are the aggregated result of everyone’s predictions about “how much value the company can create in the future.” These predictions form stock prices at the point where market supply and demand meet.
According to the ‘Asset Pricing Theory’ in finance, a company’s value is determined by the present value of all future profits it will generate. In other words, the current stock price represents the aggregate of expectations for the total profits the company will create in the future.

Why the stock price of a loss-making company rises

Within this structure, the reason why the stock price of a company currently operating at a loss rises is simple.
It is precisely because of the expectation that the company will generate high profits in the future.
For example, let’s assume there is a technology company that currently cannot escape operating at a loss. Although it currently provides no value to shareholders, if that company possesses unique technological capabilities or market share, many people predict that this company will achieve explosive growth in the near future. This prediction is then immediately reflected in the current stock price.
Consequently, even if the PER exceeds 1,000 times, people tolerate that figure based on the belief that ‘future profits will catch up’. A high PER may not simply indicate overvaluation; it could reflect confidence in future growth.

Conversely, even with high profits, the stock price may fall

Conversely, even a company currently generating stable profits will see its stock price fall if the market judges its future growth expectations to be low. In such cases, the PER will actually appear low. In other words, a low PER does not necessarily mean it is an ‘undervalued blue-chip stock’. Behind the PER figure lies ‘the market’s psychology about the future’.

Emotion or Logic?

Stocks move based on logic. However, that logic lies not in the ‘past’ but in the ‘future’. Therefore, it’s difficult to judge based solely on simple numbers or current financial statements. Because market expectations and emotions are intricately intertwined, it can sometimes appear illogical. But once we understand this principle, the movement of stock prices becomes somewhat more comprehensible. The true investor’s perspective focuses less on ‘whether this company is performing well now’ and more on ‘what value this company can create in the future’.

In Conclusion

The stock market is not a simple numbers game. It is a complex ecosystem where logic and emotion, analysis and expectation, the present and the future are intertwined. But once you grasp this structure, the unknown world of stocks becomes a little less intimidating, and your investment perspective broadens. Remember: stock prices aren’t simply explained by earnings or assets; they represent the sum total of all possibilities and expectations for the future. From that moment on, the ups and downs of stocks will gradually enter the realm of ‘understandable territory’.