What it means
Reported earnings tell you what a company has already made, but investors pay for future profits. Forward-looking earnings, sometimes called forward earnings or expected earnings, are the best available estimate of those profits.
They are usually quoted per share, so that they can be compared with the share price. The numbers normally come from analysts, who build models of revenue and costs for each company they cover.
The average of these forecasts is called the consensus estimate, and it is widely quoted in financial news. Companies may also publish their own guidance, which analysts use as a starting point.
Forward earnings are the denominator in the forward P/E ratio and in measures such as the PEG ratio. When they rise, a share becomes cheaper on those measures, and when they fall, it becomes more expensive.
This explains why share prices often move sharply when a company changes its guidance, even if nothing has changed in its past results. There are sources of error.
Analysts can be over-optimistic, estimates may exclude one-off costs that are real, and forecast profits are sensitive to small changes in assumptions about growth and margins. A business with stable demand and long contracts is easier to forecast than one with volatile sales.
A practical tip is to look at how estimates are changing, not just their level. Upward revisions suggest improving conditions, and downward revisions often come before a fall in the share price.
Comparing past forecasts with actual outcomes also shows how reliable the analysts have been. Finally, remember that forward-looking earnings can be defined in different ways.
Some estimates are based on reported accounting profit, while others strip out one-off items and are labelled adjusted or underlying earnings. Always check which definition is being used before comparing two companies, as the gap can be large.
In practice
Real-world examples.
Example
An investor compares two shares in the same sector. One has a forward P/E of 12 and the other 20, and she examines the forward earnings estimates behind each. She finds that the second company's estimates include a large expected profit from a new product.
Example
A chief financial officer updates guidance after a poor first quarter, reducing the expected earnings per share from $3.20 to $2.80. The share price drops by 8% on the day, even though no new results have been published. The finance team prepares to explain the revisions to shareholders. They publish a short bridge showing how lower volumes and higher costs account for the 40 cent reduction.
Example
A private equity analyst values a target company by applying a multiple to its expected earnings for the next year. She builds her own estimate rather than using management's, and she cuts it by 10% to allow for the risk that sales growth is slower than planned. Her lower estimate leads her to recommend a bid price that is $15,000,000 below the seller's first ask.
Formula
Calculation
Forward-looking earnings per share = Sum of the expected earnings per share for each of the next four quarters
Suppose analysts expect earnings per share of $1.00, $1.10, $1.20 and $1.30 over the next four quarters. The forward-looking earnings per share are 1.00 + 1.10 + 1.20 + 1.30 = $4.60.
If the share price is $69, the forward P/E is 69 / 4.60 = 15 times. If the estimates are cut to a total of $4.00, the same price gives a forward P/E of 69 / 4.00 = 17.25 times, which makes the shares look more expensive.Case study
Seen in the real world.
Pinecrest Software is a fictional listed company with 10,000,000 shares in issue. The market expected earnings of $2.00 per share, or $20,000,000 in total, for the coming year, and the share price was $40.
In its quarterly update, management warned that a large customer had delayed a purchase and that earnings would be nearer $1.60 per share, or $16,000,000. The forward P/E rose from 40 / 2.00 = 20 times to 40 / 1.60 = 25 times.
In this illustrative example the shares fell to $32 over the following week, which brought the forward P/E back to 20 times. The market was not judging the company to be worse, only adjusting the price to reflect the lower expected earnings. The finance director used the episode to change how the company communicates. Guidance is now given as a range, reviewed monthly, and updated promptly if it moves outside that range, so that surprises are smaller in future.
Watch out
Common mistakes.
- Treating forward-looking earnings as certain, when they are estimates that are often revised.
- Mixing up the period covered, such as comparing a forecast for the next calendar year with a forecast for the next twelve months.
- Using only management's guidance, which may be more optimistic than independent analysts' estimates.
Questions
People also ask.
Where do forward-looking earnings come from?
They come from analyst forecasts, often averaged into a consensus, and from guidance published by the company itself.
How are forward-looking earnings different from trailing earnings?
Trailing earnings are what the company reported over the past twelve months, while forward-looking earnings are what is expected over the coming period.
Why do share prices move when estimates change?
The price reflects expected future profit, so a change in the estimate changes what investors are willing to pay.
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