Key Takeaways
- Forward P/E is a variation of the conventional price-to-earnings (P/E) ratio, leveraging forecasted earnings to provide valuable insights.
- Utilizing estimated earnings per share (EPS) for Forward P/E can yield potentially biased results if actual earnings diverge from projections.
- Analysts frequently use a combination of forward and trailing P/E estimates to form a more comprehensive judgment.
Unveiling Forward Price-to-Earnings (Forward P/E)
Forward price-to-earnings (Forward P/E) captures a distinctive investment analysis viewpoint by incorporating predicted earnings into the P/E calculation for future assessment. Here’s the formula:
`Forward P/E = \frac{\text{Current Share Price}}{\text{Estimated Future Earnings per Share}}
A Practical Example
Consider a company with a current share price of $50 and an EPS of $5, forecasted to grow by 10% over the coming fiscal year. Where the current P/E ratio is $50 / 5 = 10x, the Forward P/E would be $50 / (5 x 1.10) = 9.1x. This suggests the Forward P/E ratio reflects future earnings growth relative to today’s share price.
Insights from Forward Price-to-Earnings
Financial analysts perceive the P/E ratio as a metric assessing a company’s earnings yield. For example, if company A trades at $5 and company B at $10, the market apparently values company B’s earnings higher, possibly due to superior management or an exceptional business model.
Employing the trailing P/E ratio means evaluating today’s price against the last 12 months or last fiscal year earnings, whereas forward P/E uses anticipated earnings. Essentially, a lower Forward P/E hints at expected growth, while a higher ratio indicates anticipated earnings reduction.
Forward P/E vs. Trailing P/E
The distinction between Forward and Trailing P/E lies in Forward P/E’s use of projected EPS, while Trailing P/E relies on past performance via current share price compared to EPS over the past year. Trailing P/E’s objectivity based on reported earnings makes it widely favored, though it underscores the need to focus on future earnings potential for investors.
Limitations of Forward P/E
Depending on Forward P/E alone carries the risk of miscalculation or biases since it’s built on estimated future earnings. Companies might understate or overestimate earnings for various strategic reasons, leading to confusion. Thorough research and combining forward with trailing P/E can lead to more reliable decisions.
Calculating Forward P/E in Excel
Calculating Forward P/E in Excel for comparative purposes is straightforward:
- Setup Columns: Label two columns for the companies.
- Enter Data: Add market price per share and forecasted EPS for both companies.
- Calculate P/E: Use the formula in Excel to determine Forward P/E. For example:
Assume company ABC has a market price per share of $50 and an expected EPS of $2.60:
- Enter
Company ABCinto cell B1. - Input
=50into cell B2 and=2.6into cell B3. - In cell B4, calculate with
=B2/B3, resulting in a Forward P/E of 19.23.
For company DEF with a market value per share of $30 and expected EPS of $1.80:
- Enter
Company DEFinto cell C1. - Input
=30into cell C2 and=1.80into cell C3. - In cell C4, calculate with
=C2/C3, giving a Forward P/E of 16.67.
This method ensures you make informed, strategic investment decisions backed by accurate financial analysis.
Related Terms: Trailing P/E, Earnings Per Share, Market Value, Investment Thesis.
References
- YCharts. “Forward PE Ratio”.
