What is 'Trailing Price-To-Earnings - Trailing P/E'
Trailing price-to-earnings (P/E) is calculated by taking the current stock price and dividing it by the trailing earnings per share (EPS) for the past 12 months. This measure differs from forward P/E, which uses earnings estimates for the next four quarters. As a result, forward P/E can sometimes be more relevant to investors when evaluating a company.
BREAKING DOWN 'Trailing Price-To-Earnings - Trailing P/E'
The P/E ratio is calculated by dividing a company's stock price by its earnings from the most recent fiscal year. The earnings for the most recent fiscal year can be found in the annual report on the income statement. At the bottom of the income statement is a total EPS for the firm's entire fiscal year. Divide the current price by this number for the traditional P/E ratio. For example, a company with a stock price of $50 and EPS of $2 has a P/E ratio of 25x, read 25 times. This means that the company's stock is trading at 25x its EPS.
Why Do Analysts Use P/E
Analysts like the P/E ratio because it places a relative 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 and have deeper economic moats, but some companies are simply overpriced. Likewise, some firms deserve a lower price tag because they have an unproven track record, while others are underpriced, representing a great bargain. Trailing P/E helps analysts match time periods for a more accurate and up-to-date measure of relative value.
A disadvantage of the P/E ratio is that stock prices are constantly moving, while earnings remain fixed. Analysts attempt to deal with this issue by using the trailing P/E ratio, which uses earnings from the most recent four quarters rather than earnings from the end of the last fiscal year.
Using the same example, if the company's stock price falls to $40 midway through the year, the new P/E ratio is 20x, which means the stock's price is now trading at only 20x its earnings. Earnings have not changed, but the stock's price dropped. Earnings for the last two quarters may have also dropped. In this case, analysts can substitute the first two quarters of the fiscal year calculation with the most recent two quarters for a trailing P/E ratio. If earnings in the first half of the year, represented by the most recent two quarters, are trending lower, the P/E ratio will be higher than 20x. This tells analysts that the stock may actually be overvalued at the current price given its declining level of earnings.