When it comes to analyzing stocks, there is more than one flavor of price-to-earnings ratios (P/E). The most common is the trailing P/E. which divides the current share price of a stock by the annual earnings from the past 12 months. This is usually the number that you will see analysts, the media, and most investing websites use.

There are a couple more different ways to calculate the price-to-earnings of a stock that could be useful to shareholders. The forward P/E is a popular choice and uses future estimates to calculate the ratio. Some investors even split the difference by using the past two quarters results plus the estimated future two quarters. Each ratio has its own advantages and disadvantages and should be fully understood before used to make critical investment decisions.

What Does Forward P/E Mean?

The forward P/E of a stock uses a different earnings number than the traditional or trailing P/E. Instead of using past numbers, the equation takes the current price per share and divides it by earnings forecast for the next 12 months.

Forward P/E = Current Share Price / Estimated Earnings

In this case, the estimated numbers could represent the next 12 months or the next fiscal year of the company. Most websites and brokers use the next fiscal year estimates, but it is up to the investor to decide which they prefer to use.

If company ABC currently trades at $25 per share and reported earnings for the past 12 months of $1.25 per share, the trailing P/E would equal 20. Lets assume that the average consensus anticipates the company to increase its earnings by $0.15 per share over the next year. The following calculation can be used to find the forward P/E of the company.

Forward P/E = $25 / $1.40 or 17.8

As you can tell, based on a expected earnings increase, the current share price seems to be a bargain compared to the current earnings.

Final Thoughts

While the earnings used to calculate the forward P/E are estimates, the ratio can prove beneficial to investors. The results can be compared to the trailing P/E to determine the current value of the investment versus 12 months (or by the next fiscal year) from now.

If the estimated future earnings of a company are higher than the current earnings, the forward P/E will be lower than the trailing results. However, if the earnings are forecast to drop then the forward P/E will be higher.

Do you prefer to use the trailing, forward, or both price-to-earnings values when analyzing stocks?