What is Forward Price To Earnings - Forward P/E
Forward price to earnings (forward P/E) is a quantification of the ratio of price-to-earnings (P/E) 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 primary methods for valuing stocks: 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 more. There can be various interpretations as to why company B is valued more. It could mean 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; however, 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.