Forward Price to Earnings (Forward P/E)

A variation of the price-to-earnings ratio known as the forward price-to-earnings (Forward P/E) uses projected earnings to determine the P/E ratio. There are advantages to estimated P/E analysis, even though the earnings employed in this calculation are only estimates and not as trustworthy as actual or historical earnings data.

The forward P/E ratio, also known as the forward price-to-earnings ratio, is calculated by dividing a company's current share price by its anticipated future ("forward") earnings per share (EPS). A forward P/E ratio is often thought to be more pertinent than a historical P/E ratio for valuation purposes.

Projected earnings per share, or the earnings anticipated to be produced per share over the upcoming 12 months, may be used by investors or analysts. The leading or anticipated P/E are other names for this variation. The key distinction is that the forward P/E is based on analyst predictions of a company's future or forward earnings instead of using historical data.

This Article serves as a Forward PE Ratio guidance. Here, we go over the formula for calculating the forward PE ratio, an illustration, and the distinction between the forward PE ratio and trailing PE.

Understanding Forward Price-to-Earnings (Forward P/E)

The forecasted earnings in the method below are typically expected earnings for the coming year's first quarter or anticipated earnings for the following full fiscal year (FY). The trailing P/E ratio can be compared to the forward P/E ratio.

The forward P/E ratio is calculated using the same method as the traditional P/E ratio, but estimates (or forecasts) of earnings per share are used in place of historical data.

The formula for forward P/E = Present Share Price / Projected Earnings Per Share

Assume, for instance, that a company's shares now trade for $50 and that its earnings per share for this year are $5. The company's current P/E ratio is $50/5, which equals 10x. Over the upcoming fiscal year, analysts predict that the company's earnings will increase by 10%.

On the other side, the forward P/E would be $50 / (5 x 1.10) = 9.1x, because the forward P/E measures future earnings growth compared to today's share price, it is important to note that it is lower than the present P/E.

A higher P/E ratio indicates that a firm (or sector) may be "more expensive" to buy at today's price when compared to lower P/E ratio companies. Or it can indicate that investors are willing to pay more for particular businesses. The market may also undervalue the company at this specific time if Company A trades on a 1-year future P/E of 12.1x when it typically trades on a 1-year forward of 16.3x. It would be necessary to conduct more research.

What Does Forward Price-to-Earnings Reveal?

The P/E ratio is sometimes referred to as an earnings price tag by analysts. It is used to determine a relative value based on a firm's earnings. Theoretically, $1 of earnings at business A and $1 at company B are equivalent. If so, both businesses should be trading at the same price, but this isn't usually the case.

The market must appreciate business B's earnings greater if company B is trading for $10 while company A is trading for $5. There are several possible explanations for why firm B is valued higher. It can imply that the earnings of firm B are overestimated. It can also imply that Company B deserves a higher valuation for its earnings due to greater management and a stronger business strategy.

Analysts calculate the trailing P/E ratio by comparing the price of the stock today to its earnings for the previous fiscal year or the previous twelve months. Both, meanwhile, are based on past pricing. Analysts utilize earnings estimates to predict the firm's relative worth at a certain level of profits. The forward P/E estimates the relative worth of the profits.

The future P/E ratio, or half the value of the firm when it has $1 in profits, is 5x, for instance, if the current price of company B is $10 and earnings are expected to double to $2 next year.

Forward P/E on Company Outlook

The price-to-earnings ratio (P/E ratio) evaluates a company's share price with its earnings per share. Divide the market value per share by the profits per share in the formula to determine this ratio (EPS). The EPS from a company's most recent four quarters is used in the standard P/E ratio calculation.

Projected earnings per share, or the earnings anticipated to be produced per share during the upcoming 12 months, may be used by investors or analysts. The forward P/E is a version of this computation. The leading or anticipated P/E are other names for this variant. The key distinction is that the forward P/E is based on analyst predictions of a company's future or forward profits instead of using historical data.

Forward P/E vs. Trailing P/E

Projected EPS is used in forward P/E. The current share price is divided by the total EPS earnings for the previous 12 months to calculate the trailing P/E, which is based on prior performance. The most common P/E statistic is the trailing P/E because, provided the firm correctly recorded earnings, it is the most objective. Since they don't believe other people's earnings projections, some investors prefer to look at the trailing P/E ratio. The forward P/E ratio should be seen more in the market's anticipation of future growth for a company.

However, trailing P/E also has certain drawbacks, mainly that previous performance may not always predict future behavior. Therefore, rather than basing financial decisions on the past, investors should do so. Another issue is that the stock prices change while the EPS number stays the same. The trailing P/E won't accurately represent changes in stock price if a significant corporate event causes it to move sharply higher or down.

Note - Forward P/E is calculated as Current Price/Future Estimated EPS; a higher future EPS will result in a lower Forward P/E. Future growth is implied if the stock price increases more than the estimated EPS.

In the end, the P/E ratio is a number that gives investors more insight into the worth of a stock than the market price alone. When contrasting similar businesses within the same industry, the P/E ratio and forward P/E ratio are very useful.

How to Calculate Forward P/E in Excel

Microsoft Excel may determine a company's forward P/E for the following fiscal year. As was previously said, the forward P/E is calculated by dividing a company's market price per share by its anticipated profits per share. By right-clicking on each of the columns and then left-clicking on "Column Width," in Microsoft Excel, you can make columns A, B, and C wider by setting the number to 30.

Consider a scenario where you wish to evaluate the forward P/E ratio of two businesses in the same industry. Put the first company's name in cell B1 and the second company's name in cell C1. Then:

• Cell A2 should be filled out with "Market price per share," and cells B2 and C2 should be filled out with the matching market prices per share for the firms.
• Next, input "Forward earnings per share" and the equivalent number for the firms' anticipated EPS for the following fiscal year into cells A3, B3, and C3, respectively.
• In cell A4, type "Forward price to earnings ratio" after that.

Assume, for instance, that business ABC is now trading at $50 and expects to earn $2.60 per share. Cell B1 should now read "Company ABC." Put "=50" in cell B2 and "=2.6" in cell B3, then press "Enter." Put "=B2/B3" in cell B4 after that. As a consequence, ABC Company's forward P/E ratio is 19.23.

The firm DEF, on the other hand, now has a projected EPS of $1.80 and a market value per share of $30. Cell C1 should now read "Company DEF." Then type "=30" in cell C2 and "=1.80" in cell C3, respectively. Put "=C2/C3" in cell C4 after that. The firm DEF's forward P/E, as a consequence, is 16.67.

Example of Forward P/E Ratio

Calculating the anticipated EPS is the most difficult task regarding Forward P/E. Since the stock's current price dominates the market, it is simple to determine the current market price. You may get the anticipated EPS on third-party websites like Bloomberg and Yahoo Finance or make your own reports. The future EPS of a share may also be predicted using analyst consensus. The average of all the EPS estimates provided to IBES or Bloomberg by different equities research analysts following a specific stock is known as analyst consensus.

The future-oriented template appears as follows:

Here, we can see the ABC Corp. stock now trading for $60 a share. Based on actuals for 2020 and projections for 2021 and 2022, we have three numbers for EPS. For our computation of the future price-to-earnings ratio, we may either use the average of the two expected years or utilize it; alternatively, we can take the projected earnings of only one estimated year and proceed as necessary. In this instance, $2.55 is the appropriate average EPS for the two predicted years, 2021 and 2022. The following calculation should be used to get the forward P/E right now:

Current Share Price / Projected Future Earnings per Share is the forward P/E ratio.

Therefore, based on the average of two years' worth of projections, the forward P/E will be $60/$2.55 = 23.5.

Similarly, if we use the expected EPS for the following year rather than the average, the forward P/E calculation will often result in $60/$2.5 = 24.

How to Compare Companies by P/E Ratio

Imagine that one business, Toro, announced earnings of Rs 15 per share while another, Boro, recorded earnings of Rs 25 per share. The P/E ratios of Toro and Boro are 8 and 10, respectively.

In this case, purchasing shares of Boro is preferable because it offers investors higher earnings per share for a nearly identical P/E ratio. Investors receive Rs 25 for each share of Boro, which is a two-thirds increase above the earnings per share of Toro.

Limitations of Forward P/E

When evaluating a firm as a possible investment, future P/E can give an investor important information, but it also has certain drawbacks. One barrier is the possibility of an organization's predicted profits being off. The findings of the future P/E ratio will be incorrect if actual earnings are much higher or lower.

To surpass consensus predictions, it's possible that firm management could understate future earnings. Additionally, they might need to occasionally modify their profit projections in reaction to new information or shifting market dynamics. A new computation would thus be necessary for a more accurate portrayal of a company's worth, perhaps making a forward P/E calculation outdated. Analysts could create forward P/E projections, which could be inaccurately computed or exposed to model risk because of faulty programming or inaccurate data.

It's wise to take into account several elements rather than depending on just one indicator to support your investment research. Before making an investment choice, many investors examine both the future and trailing P/E projections as well as the financial statements of a firm.

Key Takeaways

• The price-to-earnings ratio, known as the Forward P/E, uses projected earnings to calculate the P/E ratio.
• Forward P/E may generate inaccurate or skewed findings if real profits differ since it uses predicted earnings per share (EPS).
• To improve their assessments, analysts frequently blend future and trailing P/E projections.
• The use of forward P/E for investment research has limitations, such as model risk brought on by incorrect programming or data and companies that estimate predicted earnings incorrectly.
• The easiest way to understand a company's investment potential is to mix the forward P/E with other ratios, including the trailing P/E.

Conclusion

When a potential investor wants to perform a complete technical study of a firm before investing, the future price-to-earnings ratio is a highly useful tool. Although technology offers a great deal of knowledge, wholly relying on it also necessitates a high degree of experience. Utilizing the trailing price-to-earnings ratio and the forward price-to-earnings ratio, which will provide a buffer between the current performance and the performance expected in the future, is the best course of action. However, the consensus version of the forward price-to-earnings ratio, which is based on projections provided by many qualified experts, still has some validity.