What is Trailing P/E vs. Forward P/E?
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.
Understanding Trailing P/E vs. Forward 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 estimates, creating confusion.
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