The price-to-earnings (P/E) ratio is arguably the most effective and often used valuation metric in equity analysis. This article explains how to calculate the trailing twelve-month (TTM) P/E, and the forward P/E, and examines how P/E analysis applied to entertainment content behemoth Netflix, Inc. (NFLX), in 2018-2019.
Trailing Twelve-Month (TTM) P/E
To determine this calculation, one must first understand the underlying components, which are as follows:
- The numerator of the P/E ratio is the current price of the stock, symbolized by the letter “P.”
- The denominator of the P/E ratio is the earnings-per-share (EPS), symbolized by the letter “E.” The EPS is itself a ratio that breaks earnings down by the company’s shares outstanding, which can be calculated as follows:
(net income – preferred (net income – pre dividends) / weighted average number of diluted outstanding shares = EPS
Together, the price divided by the EPS results in the P/E, which reflects how much investors are willing to pay per $1 of a company’s earnings. The price portion is straightforward. One must simply pull up Netflix’s share price (the numerator) on any given day. Determining the denominator is also easy for investors, because the Securities and Exchange Commission requires all public companies to report this ratio in their quarterly Form 10-Qs and annual 10-Ks.
Bear in mind that EPS is a breakdown of the company’s earnings by outstanding shares, which are fluid and ever-fluctuating. If shares outstanding increase, EPS will decrease, and vice versa. Furthermore, EPS is typically calculated using diluted shares, taking into account any convertible shares that may be issued through bonds, warrants, employee benefits, or other sources.
For a TTM P/E example, consider Netflix’s reported EPS for the last four quarters through October 2018:
- Q3/2018: $0.89
- Q2/2018: $0.85
- Q1/2018: $0.64
- Q4/2017: $0.41
Adding these figures up yields a TTM EPS of $2.79. And by dividing Netflix’s October 24, 2018 closing price of $305.00 by that number, we arrive at $109.3 ($305/2.79), which is NFLX’s TTM P/E ratio on that day. This tells us that at that time, investors were willing to pay $109.3 per $1 of NFLX’s earnings.
While TTM P/E calculations are objectively measured by historical data, forward P/Es are subjective calculations that consider a company’s projected earnings-per-share growth. The growth rate can be inferred through management guidance, industry prospects, and growth models based on fundamentals, such as return on invested capital.
For 2019, analysts projected an average EPS of $4.21 for Netflix. But keep in mind that the forward P/E also uses the current price of the stock in the numerator. Consequently, determining the forward P/E required the following calculation: $305/$4.21 = 72.50. As was typically the case, the forward P/E was lower due to a higher EPS projection at that time.
P/E values can be considered in the context of a company’s competitors. Consider the following TTM and forward P/E ratios for several of Netflix’s rivals: (Note: this analysis also considers price-to-sales (P/S) ratio.)
|Name||Ticker||$ Price||TTM P/E||Forward P/E||P/S|
|Alphabet Inc. A||GOOGL||1,057.05||44.73||22.78||5.88|
|Comcast Corp A||CMCSA||34.12||6.50||12.12||1.74|
|Facebook Inc A||FB||146.11||22.17||18.38||8.83|
This data shows that Netflix had the second-highest TTM P/E and the highest forward P/E. Growth data for the first three quarters of 2018 tells us that revenue had been growing at a 25% rate, and earnings were expected to grow at a rate ranging from 50% to 100%. Netflix also boasts one of the highest P/S ratios.