Definition
Trailing PE (Price to Earnings) Ratio is a valuation ratio calculated by dividing the market price per share by the earnings per share (EPS) over the past 12 months. Forward PE Ratio, on the other hand, uses the forecasted earnings for the next 12 months instead of past earnings. These ratios are used by investors to assess the company’s profitability and to determine if their shares are overvalued or undervalued.
Key Takeaways
- The Trailing PE Ratio is a valuation ratio that makes use of the previous year’s earnings for its calculations, reflecting the company’s past performance. It is derived by dividing the market value per share by the earnings per share (EPS) from the last 12 months.
- On the other hand, the Forward PE Ratio is another valuation ratio, but it uses the projected earnings for its computation. It gives a picture of what the market anticipates the company’s earnings to be in the future. This ratio is calculated by dividing the market value per share by the predicted EPS for the next 12 months.
- A comparison between the Trailing PE Ratio and the Forward PE Ratio can give potential investors a more rounded view of a company’s financial situation. If the Forward PE Ratio is lower than the Trailing PE Ratio, it could signal that the market expects the company’s earnings to grow. However, if the Forward PE is higher, it could indicate reduced earnings expectations.
Importance
The finance terms Trailing Price-to-Earnings (PE) Ratio and Forward PE Ratio are important because they serve as key indicators of a company’s profitability, helping investors make informed decisions.
The Trailing PE Ratio is based on the company’s previous 12 months of earnings, offering a snapshot of how the company has performed in the recent past.
On the other hand, the Forward PE Ratio represents analysts’ expectations of the company’s earnings in the future.
Comparing these two ratios can signal whether the company’s earnings are expected to improve, remain steady, or decline.
Hence, they provide critical insights about the company’s financial health and future prospects that aid in investment decision-making.
Explanation
The Trailing Price-Earnings (PE) Ratio and Forward PE Ratio are both essential metrics in financial analysis and valuation. They facilitate investors’ understanding of a company’s earnings relative to its stock price and give insight into the company’s future financial health.
The purpose of the Trailing PE Ratio is to measure a company’s recent valuation and performance by utilizing the earnings of its previous fiscal year. Investors use this ratio to gauge whether a company’s stock price is overvalued or undervalued.
It provides a snapshot of a company’s current market price in comparison to its historical earnings per share (EPS).On the other hand, the Forward PE Ratio focuses on a company’s predicted future earnings. This ratio provides an estimate of a company’s future growth prospects, and it helps investors make decisions based on speculation of future earnings rather than past performance.
It’s calculated by dividing the current share price by the estimated future EPS. Because the Forward PE Ratio is based on future earnings projections, it can be more relevant to growth-oriented investors who are more concerned with a company’s future performance rather than past results.
Examples of Trailing PE vs Forward PE Ratio
Trailing and forward price-to-earnings (PE) ratios are important investment valuation tools. Here are three real-world examples involving these ratios.Amazon, Inc. – As of end of 2021, Amazon had a trailing PE ratio of about
This number is calculated by taking its current market price and dividing it by its earnings-per-share (EPS) over the last 12 months. At the same time, Amazon’s forward PE was aroundThis future-focused ratio is calculated by taking the current market price and dividing it by the predicted EPS for the next 12 months. The lower forward PE indicates expectations of increased earnings.
Tesla, Inc. – As of mid-2021, Tesla’s trailing PE ratio was extremely high, largely due to its elevated stock price and comparatively lower earnings. However, its forward PE ratio was much lower, which suggested analysts expected the company’s earnings to grow significantly in the future, making the stock’s high price potentially justifiable.Johnson & Johnson – As of early 2022, this healthcare company had a trailing PE ratio of approximately 22, while its forward PE ratio was around
This decrease suggested that financial analysts expected Johnson & Johnson’s earnings to grow in the next 12 months, making it potentially a good investment.
FAQs: Trailing PE vs Forward PE Ratio
What is Trailing PE Ratio?
Trailing PE Ratio is a valuation ratio calculated by dividing the current market price of a stock by its earnings per share (EPS) over the past 12 months. It reflects how much investors are willing to pay per dollar of earnings a company has made in the past year.
What is Forward PE Ratio?
Forward PE Ratio is a valuation ratio calculated by dividing the current market price of a stock by its anticipated earnings per share (EPS) for the next 12 months. It represents how much investors are willing to pay per dollar of earnings a company is expected to make in the future.
What is the difference between Trailing and Forward PE Ratio?
The core difference between Trailing PE and Forward PE ratio lies in the earnings figure used in the calculation. Trailing PE ratio uses the earnings from the last 12 months, while the Forward PE ratio uses anticipated earnings for the next 12 months. The Trailing PE ratio reflects the company’s past performance, while the Forward PE ratio reflects the market’s expectations for the company’s future performance.
Is a high PE ratio good or bad?
A high PE ratio can indicate that the stock’s price is high relative to earnings and possibly overvalued. Conversely, a low PE ratio might suggest that the current stock’s price is low relative to earnings, indicating that it may be undervalued. However, this might not always be the case as PE ratios can be influenced by other factors such as growth expectations and risk.
How are the PE ratios used in stock valuation?
Both Trailing PE and Forward PE ratios are used to measure a company’s current share price relative to its per-share earnings. While both ratios can help investors assess the value and future potential of a stock, the Forward PE ratio is more forward-looking and takes into account the market’s future expectations.
Related Entrepreneurship Terms
- Earnings Per Share (EPS): This is the portion of a company’s profit allocated to each outstanding share of common stock. It serves as an indicator of a company’s profitability and is often used to calculate PE ratios.
- Price to Earnings Ratio (P/E Ratio): A valuation ratio of a company’s current share price compared to its per-share earnings. It’s used to determine the relative value of a company’s shares in an apples-to-apples comparison.
- Trailing P/E: A valuation ratio calculated by taking the latest closing price and dividing it by the most recent earnings per share(EPS) number. The trailing P/E ratio means the ratio is relative to the company’s actual income over the past 12 months.
- Forward P/E: A version of the ratio of price-to-earnings which uses forecasted earnings for the P/E calculation. While the earnings used in this formula are an estimate and are not as reliable as current earnings data, the estimate are often used as a stand-in for future earnings.
- Equity Valuation: The process of measuring the value of a company by evaluating its current market value, financial statements, and other market factors. It is a key factor to understand while considering trailing and forward P/E ratios.
Sources for More Information
- Investopedia: An extensive resource for understanding financial terms and concepts, including Trailing PE vs Forward PE Ratio.
- Seeking Alpha: Offers investment research and financial analysis on Trailing PE vs Forward PE Ratio.
- Morningstar: Comprehensive resource with articles and research on a range of financial topics, including Trailing PE vs Forward PE Ratio.
- The Motley Fool: Known for its clear explanations and in-depth analysis of financial topics, including Trailing PE vs Forward PE Ratio.
