What it means
The ordinary or trailing P/E uses profits the company has already reported. Forward P/E swaps those historic profits for estimates of next year's profits, usually the average forecast from the analysts who follow the company.
If earnings are expected to rise, the forward P/E will be lower than the trailing P/E, and if earnings are expected to fall it will be higher. Investors like the measure because share prices reflect the future, not the past.
A business that has just been through a poor year may look expensive on trailing earnings, but cheap on forward earnings if a strong recovery is expected. Comparing the two ratios side by side gives a quick read on market expectations.
The weak point is the forecast itself. Analysts can be too optimistic, and management teams sometimes guide estimates that are easy to beat, so the forward number is only as reliable as the assumptions behind it.
When different sources show different forward P/E ratios for the same share, it is usually because they use different forecasts or different time windows. Forward P/E should be compared like with like, which means against similar companies and the same company's own history.
A software company growing quickly will normally trade on a higher multiple than a slow-growing utility, and neither number is good or bad on its own. Finance teams also use it in acquisition work to judge whether a bid price is justified by expected profits.
It does not capture debt, cash flow or the quality of earnings. A company with heavy borrowing or one-off accounting gains in its forecast can show an attractive ratio while carrying risks that the ratio ignores.
Use it alongside measures such as enterprise value to EBITDA and free cash flow.
In practice
Real-world examples.
Example
An equity analyst compares two retailers. One trades at a forward P/E of 12 and the other at 22, and she investigates why the second is so much higher. She finds that it is expanding rapidly online and is expected to double its profit within three years.
Example
A manufacturing company in a downturn reports earnings per share of $0.50, giving a trailing P/E of 80 at a $40 share price. Analysts forecast a recovery to $2.50, which gives a forward P/E of 16. The investor sees the shares are not as expensive as they first appeared.
Example
A corporate development team at a food business is valuing a target. The target's forward P/E is 14, while the sector average is 18. The team asks whether the discount reflects genuine weakness or whether the bid can be made at a fair price.
Formula
Calculation
Forward P/E = Current share price / Expected earnings per share over the next 12 months
Suppose a company's shares trade at $60 and its reported earnings per share for the last twelve months were $3.00. The trailing P/E is 60 / 3.00 = 20 times. Analysts expect earnings per share of $4.00 over the next twelve months, so the forward P/E is 60 / 4.00 = 15 times.
The ratio fell from 20 to 15 because earnings are expected to grow by (4.00 - 3.00) / 3.00 = 33.3%. An investor is paying $15 for each $1 of expected profit instead of $20 for each $1 of past profit.Case study
Seen in the real world.
Lakeshore Instruments is a fictional listed company that makes laboratory equipment, and its shares trade at $90. Last year's earnings per share were $3.00, so on the trailing measure the stock stood at 30 times earnings and looked very expensive.
A fund manager studied the forward P/E instead. Analysts forecast earnings per share of $5.00 for the coming year because a large government contract was due to start, which gave a forward P/E of 90 / 5.00 = 18 times.
In this illustrative case the manager bought the shares, but also noted that the forecast depended on the contract starting on time. When the start slipped by six months and the estimate fell to $4.00, the forward P/E rose to 22.5 times, and the manager trimmed the holding. The lesson is that the ratio is only as good as the forecast beneath it.
Watch out
Common mistakes.
- Treating analyst forecasts as facts, when they are estimates that are often revised.
- Comparing the forward P/E of companies in very different industries, where normal multiples differ widely.
- Using a low forward P/E as a sign of a bargain without checking why the market is pricing the shares so low, such as high debt or falling demand.
Questions
People also ask.
Is forward P/E better than trailing P/E?
Neither is better in all cases, since trailing uses real reported profits while forward reflects expectations, and the two are most useful when read together.
Where do forward earnings estimates come from?
They usually come from the consensus (average) forecast of analysts covering the company, or from the company's own guidance.
What is a good forward P/E?
There is no universal answer, because it depends on the industry, growth rate and interest rates, so compare it with peers and the company's own history.
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