Trailing Price-To-Earnings (Trailing P/E)

What Is Trailing Price-To-Earnings?

Trailing price-to-earnings (P/E) is a relative valuation multiple that is based on the last 12 months of genuine earnings. It is calculated by taking the current stock price and separating it by the trailing earnings per share (EPS) for the past 12 months.

Trailing P/E can be contrasted with the forward P/E, which instead uses projected future earnings to calculate the price-to-earnings ratio.

Understanding Trailing Price-To-Earnings (P/E)

The price-earnings ratio, or P/E ratio, is calculated by partitioning a company's stock price by its earnings from the latest fiscal year. When people refer to the P/E ratio generically, they are typically referring to the trailing P/E. It is calculated by partitioning the current market value, or share price, by the earnings per share (EPS) over the previous 12 months.

The earnings for the latest fiscal year can be found on the income statement in the annual report. At the bottom of the income statement is a total EPS for the company's entire fiscal year. Divide the company's current stock price by this number to get the trailing P/E ratio.

Trailing P/E Ratio = Current Share Price/Trailing 12-Month EPS

This measure is considered the reliable since it is calculated based on genuine performance rather than expected future performance. However, a company's past earnings are not necessarily consistently a decent predictor of future earnings, thus alert is warranted

For what reason Do Analysts Use P/E?

Analysts like the P/E ratio because it creates an apples-to-apples evaluation of relative earnings. The P/E ratio can hence be used to search for relative bargains in the market or to determine when a stock is too expensive compared to others. Some companies deserve a higher P/E multiple because they have deeper economic moats, yet some companies with high share price relative to earnings are simply overpriced. Likewise, some organizations deserve a lower P/E because they represent a great bargain, while other company's are justified in a low P/E due to financial weakness. Trailing P/E helps analysts match time periods for a more accurate and up-to-date measure of relative value.

A disadvantage of the P/E ratio is that stock prices are continually moving, while earnings remain fixed. Analysts attempt to deal with this issue by utilizing the trailing price-to-earnings ratio, which uses earnings from the latest four quarters rather than earnings from the end of the last fiscal year.

Example of Trailing Price-To-Earnings

For example, a company with a stock price of $50 and year trailing EPS of $2, in this manner has a trailing P/E ratio of 25x (read 25 times). This means that the company's stock is trading at 25x its trailing year earnings.

Utilizing the same example, assuming the company's stock price tumbles to $40 halfway as the year progressed, the new P/E ratio is 20x, and that means the stock's price is currently trading at just 20x its earnings. Earnings have not changed, yet the stock's price has dropped.

Earnings for the last two quarters might have additionally dropped. In this case, analysts can substitute the initial two-quarters of the fiscal year calculation with the latest two quarters for a trailing P/E ratio. If earnings in the main half of the year, represented by the latest two quarters, are trending lower, the P/E ratio will be higher than 20x. This tells analysts that the stock may really be overvalued at the current price given its declining level of earnings.

Trailing versus Forward P/E

The trailing P/E ratio differs from the forward P/E, which uses earnings estimates or forecasts for the next four quarters or next projected 12 months of earnings. As a result, forward P/E can sometimes be more relevant to investors when evaluating a company. Nonetheless, as forward P/E relies on estimated future earnings, it is prone to miscalculation as well as the bias of analysts. Companies may likewise underestimate or mis-state earnings to beat consensus estimate P/E in the next quarterly earnings report.

The two ratios are useful during acquisitions. The trailing P/E ratio is an indicator of past performance of the company being acquired. Forward P/E represents the company's guidance for the future. Typically valuations of the acquired company are based on the latter ratio. However, the buyer can use a earnout provision to lower the acquisition price, with the option of making an extra payout in the event that the targeted earnings are achieved.

Highlights

• Trailing P/E is considered a useful indicator to standardize and compare relative share price between time periods and among companies.
• Trailing P/E, however widespread being used, is limited in that past earnings may not accurately reflect the current or future earnings situation of the company.
• The trailing price-to-earnings ratio takes a gander at a company's share price in the market relative to its past year's earnings per share.