[ad_1]
:max_bytes(150000):strip_icc():format(jpeg)/thinkstockphotos_80410231-5bfc2b97c9e77c0026b4fb20.jpg)
Forward P/E vs. Trailing P/E: An Overview
The forward P/E uses projected future earnings to calculate the price-to-earnings ratio. The trailing P/E, which is the standard form of a price-to-earnings ratio, is calculated using recent past earnings.
It can be helpful for investors to consider both calculations of the P/E ratio. If an investor has noted the forward P/E ratio from the previous year, the investor can check to see how accurate the previous year’s estimated P/E was based on the current P/E.
Forward P/E calculations are also helpful in comparing the likely future performance of similar companies in the same industry.
Key Takeaways
- Trailing P/E is calculated by dividing the current market value, or share price, by the earnings per share over the previous 12 months.
- The forward P/E ratio estimates a company’s likely earnings per share for the next 12 months.
- The primary difference between the two ratios is that the trailing P/E is based on actual performance statistics, while the forward P/E is based on performance estimates.
Trailing P/E
When analysts refer to the P/E ratio, they are usually referring to the trailing P/E. It is calculated by dividing the current market value, or share price, by the earnings per share over the previous 12 months.
This measure is considered the more reliable of the two metrics since it is calculated based on actual performance rather than expected future performance. However, it could prove a limited or faulty estimate since a company’s performance factors, costs, and profits change over time.
But the trailing P/E has its share of shortcomings, namely, a company’s past performance does not signal future behavior. The fact that the earnings per share number remains constant while the stock prices fluctuate is also a problem.
Important
If a news event drives the stock price significantly higher or lower, the trailing P/E will be accurate to the current state of the stock.
Stock analysts consider the trailing P/E as a type of price tag on earnings. This relative price tag can be used to look for bargains or to determine when a stock is too expensive. Some companies deserve a higher price tag because they’ve been around longer, have deeper economic moats, or a variety of other factors.
Some companies with a high trailing P/E ratio could be overpriced and deserve lower price tags for a variety of factors; others are underpriced, representing a great bargain. Trailing P/E helps analysts benchmark periods year-over-year for a more accurate and up-to-date measure of relative value.
Forward P/E
The forward P/E ratio estimates a company’s likely earnings per share for the next 12 months. The forward P/E ratio is favored by analysts who believe that investment decisions are better made based on estimates of a company’s future rather than past performance. Estimates used for the forward P/E ratio can come from either a company’s earnings release or from analysts.
Because forward P/E relies on estimated future earnings, it is subject to miscalculation and/or the bias of analysts. Also, companies might underestimate or misstate earnings to beat the consensus estimate P/E in the next quarterly earnings report.
Other companies may overstate the estimate and later update it, going into their next earnings announcement. Furthermore, external analysts may also provide estimates, which may diverge from the company’s estimates, creating confusion.
Forward P/E vs. Trailing P/E Example
Company XYZ has a stock price of $53 per share. Over the past year, the company has reported earnings per share (EPS) of $3.44. Its trailing P/E would be 15.4.
Trailing P/E = $53/$3.44 = 15.4
Company XYZ has been making investments in its infrastructure, which are expected to boost profits. As a result of these improvements, the company projects an EPS of $4.77 for the next 12 months. This forecast means the company has a forward P/E of 11.1.
Forward P/E = $53/$4.77 = 11.1
Investors and analysts comparing both the trailing P/E and the forward P/E will note that since the trailing P/E is higher than the forward P/E, it may indicate that earnings are expected to increase in the future. This would make the stock attractively priced based on future growth estimates.
It’s important to note that forward P/E is an estimate and could be optimistic, so investors should approach it with an air of caution. Comparing these two ratios alongside ratios with similar companies can help investors get a sense of overvalued or undervalued stocks to aid them in decision-making.
What Does P/E Tell You?
Price to earnings (P/E) is a financial metric that compares a company’s stock price to its earnings per share (EPS). It signifies how much investors are willing to pay (stock price) for a company’s earnings on a per-dollar basis at a specific point in time. Investors and analysts use P/E to determine whether a stock is overvalued or undervalued. A high P/E ratio signals that a stock is overvalued or that investors expect future growth. Conversely, a low P/E ratio signals that a stock is undervalued or that investors expect contraction in the future.
What Is a Good P/E Ratio?
A good P/E ratio will depend on many factors, such as the specific sector being analyzed, the current state of the economy, and the specific characteristics of the company being reviewed. As such, there isn’t a specific number or range that one can point to. It’s important to make an analysis in context and compare a company with its peers.
Generally, a high P/E ratio would indicate a company is overvalued (sell opportunity), and a low ratio would indicate a company is undervalued (buy opportunity), yet this could not be true, as a high P/E ratio might mean expected future growth for a company rather than overvaluation, for example.
What Does “Trailing” Mean in Finance?
In finance, “trailing” means a data point based on past performance. For example, “trailing 12 months” is commonly used and refers to a financial metric from the past 12 months as opposed to the previous month, quarter, or year. There is trailing 12 months (TTM) for net income, revenue, and various ratios. The goal is to smooth out the results of the past period being analyzed so investors can get a clear picture of a company’s results.
The Bottom Line
Both trailing P/E and forward P/E provide useful but different insights for investors. Trailing P/E/ is based on actual results, providing a picture of a company’s past performance and giving insight into a stock’s current value. It doesn’t consider future growth, however.
Forward P/E is just that, a valuation that takes into consideration projected future earnings. These earnings are estimates, so investors should be cautious when making decisions based on forward P/E.
[ad_2]
Source link