Finrepo » Company's Financial Accounting » Financial Ratios: Formulas and Interpretation » Forward Price-to-Earnings ratio, P/E ratio


Forward Price-to-Earnings ratio, P/E

DEFINITION:

The Forward Price to Earnings ratio (Forward P/E ratio) is the ratio of current market share price of a company to expected future earnings per share (EPS). The forward P/E ratio is the one of the types (version) of the Price-to-earnings ratio (P/E ratio).

Forward P/E ratio:

  • is a kind of price tag on earnings;
  • uses forecasted earnings for the calculations, which can either be for the upcoming 12 months or for the next full-year fiscal period;
  • shows how much investors are ready to pay today for the company's future earnings;
  • is used to compare current earnings to estimated future earnings;
  • provides clearer understanding of how the earnings will look like without charges and different accounting adjustments;
  • is typically considered more relevant rather than historical P/E ratio, as stock market is forward-looking and it is more preferred to understand what would be expected to occur in the future instead of focusing on a historical data alone;
  • sometimes stock price can change significantly (either higher or lower) in case of some major event in the company, for instance, while EPS remains constant. In that case the forward P/E ratio will more accurately reflect the current situation than trailing P/E;
  • nevertheless, it should be noted, that the predicted earnings used to calculate forward P/E ratio are not as reliable as actual historical earnings.

FORMULA for calculations:

Forward P/E ratio = Current Share Price / Estimated Future Earnings per Share


RESULT INTERPRETATION:

  • to interpret the obtained data, get more trustworthy figures and make a better conclusion, the results of both forward and trailing P/E ratio should be considered in conjunction;
  • if forward P/E Ratio is lower than the current PE Ratio, then company's earnings are expected to grow in the future;
  • if the forward P/E Ratio is higher than the current P/E ratio, then it is expected to decrease in earnings;
  • Note: earnings used in the Forward P/E ratio formula are just an estimate and may not be as reliable as current and historical earnings data.
  • Note: Keep in mind, analyst estimates can often be wrong!

EXAMPLE

Company data:

Current P/E ratio = Current Share Price / Earnings per Share = $70 / $2,14 = 32,7

Forward P/E ratio = Current Share Price / Estimated Future Earnings per Share = $70 / (2,14 x 1,30) = 25

The forward P/E takes into account future earnings growth, as a result, it is smaller than the current P/E ratio.

FIND MORE:
Fundamental Analysis Indicators

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