Trailing P/E vs. Forward 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, he 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.
- 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 is trailing P/E is based on actual performance statistics while forward P/E is based on performance estimates.
When analysts talk about the P/E ratio, they commonly refer 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 trailing P/E has its share of shortcomings, namely, a company’s past performance doesn’t signal future behavior. The fact that the earnings-per-share number remains constant, while the stock prices fluctuate, is also a problem.
If a news event drives the stock price significantly higher or lower, trailing P/E will be accurate to the current state of the stock.
Stock analysts consider the trailing P/E as a kind 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 ratios 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 time periods year-over-year for a more accurate and up-to-date measure of relative value.
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 in order 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.