The difference between forward P/E and trailing P/E
/What is Forward P/E?
Forward P/E is the estimated price-earnings ratio for the future earnings of a business. 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. Consequently, it is quite possible that an initial forward P/E prediction will never be met.
What is Trailing P/E?
Trailing P/E is the historical price-earnings ratio for a business. Most people see 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. It is commonly reported in the business press for most publicly-held companies. A concern with trailing P/E is that it does not necessarily predict the future performance of a business. This is especially the case in a turbulent industry where product cycle times are short, the barriers to entry are low, and competition is intense.
Comparing Forward P/E and Trailing P/E
The key differences between the forward P/E and trailing P/E concepts are as follows:
Source of the underlying data. 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.
Quality of the data. Trailing P/E uses actual reported data, making it more reliable as it reflects past performance. Conversely, forward P/E relies on future earnings estimates, which can be influenced by assumptions and may not materialize if a company's performance deviates from expectations.
Insights provided. Trailing P/E provides a snapshot of how the market is valuing a company based on its historical performance. It is a backward-looking metric. Conversely, forward P/E indicates market expectations of a company’s future growth and profitability. It is a forward-looking metric.
Use cases. Trailing P/E is useful for assessing past performance and comparing it to peers or industry standards. Forward P/E is more relevant for growth companies or industries where future prospects are critical, as it reflects anticipated growth and profitability.
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Alternative Measurements
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 can be substantially better than the guidance given by an overly conservative or optimistic management team.
Use in Valuing a Target Company
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.