What is 'Forward Price To Earnings - Forward P/E'
Forward price to earnings (forward P/E) is a measure of the price-to-earnings (P/E) ratio using forecasted earnings for the P/E calculation. While the earnings used are just an estimate and are not as reliable as current earnings data, there is still benefit in estimated P/E analysis. The forecasted earnings used in the formula can either be for the next 12 months or for the next full-year fiscal period.
BREAKING DOWN 'Forward Price To Earnings - Forward P/E'
There are two main ways to value a stock: with earnings or with cash flow. Cash flows are generally discounted back to a present value, while earnings are measured in terms of relative price. The most popular earnings valuation metric is the P/E ratio, which is calculated using the current stock price and historical earnings data. Forward P/E is calculated using earnings estimates rather than actual earnings.
The Price-to-Earnings Ratio
Analysts like to think of the P/E ratio as a price tag on earnings. It is used to calculate a relative value based on a company's level of earnings. In theory, $1 of earnings at company A is worth the same as $1 of earnings at company B. If this is the case, both companies should also be trading at the same price, but this is rarely the case. If company A is trading for $5 and company B is trading for $10, it means the market values company B's earnings at a higher price. This may be a sign that company B's earnings are overvalued. It could also mean that company B deserves a premium on the value of its earnings due to superior management and a better business model.
Forward Price-to-Earnings Ratio
When calculating the P/E ratio, analysts compare today's price against earnings for the last 12 months, or the last fiscal year, but both are based on historical prices. Analysts use earnings estimates to determine what the relative value of the company will be at a future level of earnings. The forward P/E estimates the relative value of the earnings. For example, if the current price of company B is $10, and earnings are estimated to double next year to $2, the forward P/E ratio is 5x, or half the value of the company when it made $1 in earnings. If the forward P/E ratio is lower than the current P/E ratio, it means analysts are expecting earnings to increase; if the forward P/E is higher than the current P/E ratio, analysts expect a decrease in earnings.