The key difference between forward P/E and trailing P/E is that the forward measurement is based on the next projected 12 months of earnings, while the trailing figure is based on the last 12 months of actual earnings. It is useful to compare the two measures to see if there is an ascending or declining trend in the projected P/E versus the baseline trailing P/E figure.
Forward PE Ratios can highlight some sentiment of a stock. If the forward P/E ratio is higher than the current P/E ratio, it indicates decreased expected earnings.
Formula
Forward PE is calculated by as current stock price over the predicted next annual earnings period.
For instance, if the stock price for Apple is 600 dollars and the predicted EPS was 45, the predicted forward P/E would be 13.3.
Trailing P/E is the sum of a company’s price-to-earnings, calculated by taking the current stock price and dividing it by the trailing earnings per share for the past 12 months. This measure differs from forward P/E, which uses earnings estimates for the next four quarters.
The trailing P/E ratio is calculated as follows:
The figure that most people see is the trailing price earnings ratio, since that is typically calculated based on the past 12 months of reported earnings, or at least the year-end reported earnings. The forward price earnings ratio is not widely distributed, for it is based on a company’s guidance, which may change as management revises its estimates for future earnings. Also, if the management team tends to be overly optimistic in its earnings forecasts, few analysts will bother to calculate the resulting forward price earnings ratio, assuming that it will be incorrect. Further, some companies prefer to issue excessively conservative guidance, so that they can more easily beat their own earnings estimates.
A different source of information for the forward price earnings ratio is the consensus earnings opinion of those analysts that routinely follow a company. Their combined judgment may result in a fairly realistic assessment of future earnings that may be substantially better than the guidance given by an overly conservative or optimistic management team.
The forward and trailing P/E concept can be a major one when dealing with a potential acquiree. The owners of the acquiree will likely demand a price that is based on forward results, if there is an expectation that earnings will increase. If so, the potential acquirer has the choice of paying the demanded price, waiting to see if the forecasted earnings are achieved, or allowing for an earnout provision that pays the owners more if the forecasted results are achieved.
