What it means
Every price to earnings ratio is a share price divided by earnings per share, but the versions differ in which earnings are used. The trailing version uses the last four reported quarters, often labelled trailing twelve months, while the forward version uses analysts' forecasts for the year ahead.
The trailing measure is popular precisely because it cannot be talked up. The earnings figure has been reported and usually audited, so the only moving part in the calculation is the share price, which the market sets rather than management.
Investors mainly use it as a relative measure. A software company on a trailing multiple of 40 and a supermarket chain on 12 are not directly comparable, but two supermarket chains on 12 and 20 raise an obvious question about why the market expects so much more from one of them.
The weakness is that the past twelve months may not represent the future. A business recovering from a bad year shows depressed earnings and an alarmingly high trailing multiple, while a company that has just booked a one-off gain can look deceptively cheap.
Two further points catch people out. A loss-making company has no meaningful trailing price to earnings ratio at all, and earnings distorted by restructuring charges or asset disposals often lead analysts to recalculate the ratio using adjusted earnings instead of the statutory figure.
In practice
Real-world examples.
Example
A private investor screens a stock market index for companies trading on a trailing multiple below 15. She then discards several that only look cheap because of one-off property disposals inflating last year's reported profit.
Example
An analyst covering a specialist retailer notes a trailing multiple of 45 against a sector average of 18. The gap is entirely explained by a warehouse fire that depressed reported earnings, and the forward multiple sits at a much more ordinary 19.
Example
A board reviewing an acquisition target compares the asking price with the target's trailing earnings. At $54,000,000 for a business earning $2,000,000 last year, the implied multiple of 27 is well above what the board pays for its own shares, so it asks for a lower price or an earn-out.
Think of it
“Trailing P/E uses actual past earnings-what you really earned, not estimates of the future.
Formula
Calculation
Trailing P/E Ratio = Current Share Price / Earnings Per Share for the Last Twelve Months
A listed consumer goods group reported net profit of $90,000,000 over the last twelve months and has 45,000,000 shares in issue. Its shares currently trade at $54.00.
Earnings per share = $90,000,000 / 45,000,000 = $2.00
Trailing P/E = $54.00 / $2.00 = 27
Investors are paying $27.00 for every $1.00 of profit the company earned last year.
The contrast with the forward measure is instructive. If profit for the coming year is expected to reach $108,000,000, forecast earnings per share would be $108,000,000 / 45,000,000 = $2.40, and the forward multiple on the same $54.00 share price would be $54.00 / $2.40 = 22.5. The lower forward figure simply reflects the expected growth in profit, not a change in the share price.Case study
Seen in the real world.
Barrowfield Foods is an invented consumer goods group used here purely as an illustrative example. Its shares traded at $54.00 while reported profit for the trailing twelve months was $90,000,000 across 45,000,000 shares, giving earnings per share of $2.00 and a trailing multiple of 27.
A pension fund analyst thought this looked expensive against a sector average of about 19, until she read the notes to the accounts. The trailing period included a nine-month factory shutdown that had cost roughly $18,000,000 of profit and was now resolved, so the underlying earnings power was closer to $108,000,000.
On that basis, in this fictional example, the forward multiple was around 22.5 rather than 27. The analyst's recommendation noted that the trailing figure was accurate but backward-looking, and that the real question was whether the shutdown was genuinely a one-off.
Watch out
Common mistakes.
- Comparing trailing multiples across different industries as though a low number always means better value.
- Using a trailing multiple for a company whose last twelve months included a large one-off gain or loss, without adjusting for it.
- Confusing the trailing and forward measures when reading commentary, since the two can differ substantially for a fast-growing or recovering company.
Questions
People also ask.
What does a high trailing multiple mean?
Usually that the market expects earnings to grow, though it can also mean last year's earnings were unusually depressed.
Can it be negative?
Not usefully; if the company made a loss, the ratio is normally shown as not meaningful rather than as a negative number.
Which is better, trailing or forward?
Neither is universally better; the trailing version is factual but backward-looking, and the forward version is forward-looking but depends on forecasts that may be wrong.
From the founder's library
Take it further with the book.
Build your financial confidence beyond this definition. Shihan's full-length guide, Accounting Fundamentals, takes the same plain-English approach and turns it into a complete, practical playbook for non-finance managers, business owners and students - with chapter-end quiz answers and presentation slides included.
25% off with code MMHQ25, applied at checkout. Priced in USD - checkout may show the equivalent in your local currency.
View the book and save 25%