What it means
A multiple compares a price with a measure of performance, and the period you choose changes the answer completely. A trailing multiple uses the last reported twelve months, while a forward multiple uses a forecast for the next twelve.
Forward multiples are preferred in most valuation work because share prices reflect expectations rather than history. If a company has just completed a large acquisition or exited a loss-making division, last year's profit is a poor guide to what an investor is actually buying today.
The obvious weakness is that the denominator is an estimate. Forecasts come from company guidance or from analysts, they are frequently too optimistic, and an unusually low forward multiple often just means the market does not believe the forecast.
In practice the multiple is used for comparison rather than in isolation. A company on 16 times forward earnings is only interesting when set against its own history, its peer group and the growth rate that is supposed to justify the number.
The same logic extends to other measures. Forward enterprise value to earnings before interest, tax, depreciation and amortisation is widely used for capital-intensive businesses, and forward price to sales is used for companies that are not yet profitable.
In practice
Real-world examples.
Example
An investment committee compares two industrial suppliers trading at the same trailing multiple of 18 times. One is on 15 times forward earnings and the other on 17 times, and the difference is entirely explained by one company having already signed a large contract starting in January.
Example
A private company preparing for sale is told by its adviser that buyers will pay around 8 times forward EBITDA. The owners spend six months securing renewals before going to market, because every $1,000,000 added to forecast EBITDA is worth roughly $8,000,000 of price.
Example
An analyst notices that a retailer trades at only 7 times forward earnings against a sector average of 14 times. On inspection the forecast assumes a 20% profit rebound that management has not committed to, so the apparent discount reflects scepticism about the forecast rather than a cheap share.
Think of it
“Forward multiple uses projected numbers-valuing based on expected future performance, not the past.
Formula
Calculation
Forward Price to Earnings = Share Price / Forecast Earnings per Share for the next twelve months
Forward Enterprise Value to EBITDA = Enterprise Value / Forecast EBITDA for the next twelve months
Worked example: a listed consumer goods company trades at $48.00 per share. It reported earnings per share of $2.40 for the last twelve months, and analysts forecast $3.00 for the next twelve months.
Trailing price to earnings = $48.00 / $2.40 = 20.0 times.
Forward price to earnings = $48.00 / $3.00 = 16.0 times.
Now take the enterprise measure. The company has 30,000,000 shares in issue, so market capitalisation is 30,000,000 x $48.00 = $1,440,000,000. Net debt is $60,000,000, giving an enterprise value of $1,440,000,000 + $60,000,000 = $1,500,000,000. Forecast EBITDA for the next twelve months is $250,000,000.
Forward enterprise value to EBITDA = $1,500,000,000 / $250,000,000 = 6.0 times.
The shares look expensive on trailing earnings at 20.0 times but far more reasonable on forward earnings at 16.0 times. The entire difference comes from the forecast 25% rise in earnings per share from $2.40 to $3.00, so the whole valuation case rests on whether that forecast is credible.Case study
Seen in the real world.
Calderfield Beverages is an illustrative and completely fictional drinks group used to show how forward multiples can mislead. It traded at $30.00 a share with trailing earnings per share of $1.00, putting it on 30 times trailing earnings, which looked expensive against a peer group on 18 times.
Management guided to earnings per share of $2.00 for the coming year, driven by a new distribution agreement, which put the shares on 15 times forward earnings and made them look cheap. Several investors bought on that basis without testing the assumption underneath it, which was that the new agreement would deliver 40% volume growth in its first year.
Actual earnings per share came in at $1.20 and the shares fell to $21.60, leaving them on 18 times the earnings actually delivered. In this fictional case nothing about the arithmetic had been wrong; the forecast in the denominator had simply been too optimistic, which is the risk in every forward multiple.
Watch out
Common mistakes.
- Comparing a forward multiple with a trailing multiple. The two use different periods, so a company on 16 times forward earnings is not cheaper than one on 18 times trailing earnings until both are put on the same basis.
- Accepting the forecast without question. The multiple is only as reliable as the earnings estimate underneath it, and a cheap-looking forward multiple usually signals doubt rather than opportunity.
- Mixing enterprise value with equity earnings. Enterprise value must be compared with a pre-interest measure such as EBITDA, while share price is compared with earnings per share after interest.
Questions
People also ask.
What does the next twelve months mean exactly?
It usually means the coming twelve months from today, which may blend part of the current financial year with part of the next rather than following the reporting calendar.
Why do forward multiples usually look lower than trailing ones?
Because forecasts generally assume growth, so a larger denominator produces a smaller multiple, and that is why the credibility of the forecast matters so much.
Which forward multiple should be used?
It depends on the business, with price to earnings suiting stable profitable companies, enterprise value to EBITDA suiting capital-intensive or highly geared ones, and price to sales suiting companies that are not yet profitable.
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