Forward Price-to-Earnings (Forward P/E)
What Is Forward Price-to-Earnings (Forward P/E)?
Forward price-to-earnings (forward P/E) is a version of the ratio of price-to-earnings (P/E) that uses forecasted earnings for the P/E calculation. While the earnings used in this formula are just an estimate and not quite so reliable as current or historical earnings data, there are still benefits to estimated P/E analysis.
Understanding Forward Price-to-Earnings (Forward P/E)
The forecasted earnings used in the formula below are typically either projected earnings for the accompanying 12 months or the next entire year fiscal (FY) period. The forward P/E can be contrasted with the trailing P/E ratio.
For example, assume that a company has a current share price of $50 and the current year's earnings per share are $5. Analysts estimate that the company's earnings will develop by 10% over the next fiscal year. The company has a current P/E ratio of $50/5 = 10x.
The forward P/E, then again, would be $50/(5 x 1.10) = 9.1x. Note that the forward P/E is smaller than the current P/E since the forward P/E accounts for future earnings growth relative to today's share price.
What Does Forward Price-to-Earnings Reveal?
Analysts like to think of the P/E ratio as a price label 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 An is worth the same as $1 of earnings at company B. If so, the two companies ought to likewise be trading at the same price, however this is rarely the case.
In the event that company An is trading for $5, and company B is trading for $10, this implies that the market values company B's earnings more. There can be different interpretations with regards to why company B is valued more. It could mean that company B's earnings are overvalued. It could likewise mean that company B deserves a premium on the value of its earnings due to superior management and a better business model.
When working out the trailing P/E ratio, analysts compare today's price against earnings throughout the previous 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. On the off chance that the forward P/E ratio is lower than the current P/E ratio, this implies that analysts are expecting earnings to increase. On the off chance that the forward P/E is higher than the current P/E ratio, analysts expect a decrease in earnings.
Forward P/E versus Trailing P/E
Forward P/E uses projected EPS. Meanwhile, trailing P/E relies on past performance by separating the current share price by the total EPS earnings over the past 12 months. Trailing P/E is the most popular P/E metric because it's the most objective ā accepting the company reported earnings accurately. Some investors prefer to take a gander at the trailing P/E because they have little to no faith in another singular's earnings estimates.
However, trailing P/E likewise has its share of weaknesses ā namely, a company's past performance does not signal future behavior. Investors ought to in this way commit money based on future earnings power, not the past. The way that the EPS number remains consistent while the stock prices fluctuate is likewise a problem. Assuming that a major company event drives the stock price fundamentally higher or lower, the trailing P/E will be less reflective of those changes.
Limitations of Forward P/E
Since forward P/E relies on estimated future earnings, it is subject to miscalculation and additionally analysts' bias. There are other inherent problems with the forward P/E moreover. Companies could underestimate earnings to beat the consensus estimate P/E when the next quarter's earnings are announced.
Other companies might overstate the estimate and later adjust it going into their next earnings announcement. Furthermore, external analysts may likewise provide estimates, which might diverge from the company estimates, creating confusion.
On the off chance that you're utilizing forward P/E as the central basis of your investment thesis, research the companies completely. Assuming the company updates its guidance, this will affect the forward P/E in a way that could cause you to change your opinion. It is great practice to use both forward and trailing P/E to come to a more trustworthy figure.
Instructions to Calculate Forward P/E in Excel
You can calculate a company's forward P/E for the next fiscal year in Microsoft Excel. As displayed above, the formula for the forward P/E is simply a company's market price per share divided by its expected earnings per share. In Microsoft Excel, first increase the widths of sections A, B, and C by right-tapping on each of the segments and left-tapping on "Segment Width" and change the value to 30.
Assume you wanted to compare the forward P/E ratio between two companies in the same sector. Enter the name of the initial company into cell B1 and the name of the second company into cell C1. Then:
- Enter "Market price per share" into cell A2, and the corresponding values for the companies' market price per share into cells B2 and C2.
- Next, enter "Forward earnings per share" into cell A3, and the corresponding value for the companies' expected EPS for the next fiscal year into cells B3 and C3.
- Then, enter "Forward price to earnings ratio" into cell A4.
For example, assume company ABC is currently trading at $50 and has an expected EPS of $2.60. Enter "Company ABC" into cell B1. Next, enter "=50" into cell B2 and "=2.6" into cell B3. Then, enter "=B2/B3" into cell B4. The resulting forward P/E ratio for company ABC is 19.23.
Then again, company DEF currently has a market value per share of $30 and has an expected EPS of $1.80. Enter "Company DEF" into cell C1. Next, enter "=30" into cell C2 and "=1.80" into cell C3. Then, enter "=C2/C3" into cell C4. The resulting forward P/E for company DEF is 16.67.
Features
- Because forward P/E uses estimated earnings per share (EPS), it might produce incorrect or biased results assuming genuine earnings prove to be different.
- Forward P/E is a version of the ratio of price-to-earnings that uses forecasted earnings for the P/E calculation.
- Analysts often combine forward and trailing P/E estimates to make a better judgment.
