Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail
Investing Answers Building and Protecting Your Wealth through Education Publisher of The Next Banks That Could Fail

Forward Price-to-Earnings Ratio

What it is:

The forward price-to-earnings ratio (forward P/E) is a valuation method used to compare a company’s current share price to its expected per-share earnings.

How it works (Example):

The market value per share is the current trading price for one share in a company, a relatively straightforward definition. However, earnings per share (EPS) may not be as intuitive for most investors. The more traditional and widely used version of the EPS calculation comes from the previous four quarters of the price-to-earnings ratio, called a trailing P/E. Another variation of the EPS can be calculated using a forward P/E, estimating the earnings for the upcoming four quarters. Both sides have their advantages, with the trailing P/E approach using actual data and the forward P/E predicting possible outcomes for the stock. Calculated as the following;

Forward Price-to-Earnings Ratio (P/E) = Market value per share / Forward Earnings Per Share (EPS)

Let’s do a sample calculation with company XYZ that currently trades at $100 and has expected earnings per share (EPS) of $5. Using the previously mentioned formula, you can calculate that XYZ’s forward P/E is 100 / 5 = 20.

Why it Matters:

The forward price-to-earnings ratio is a powerful, but limited tool. For investors, it allows a quick snapshot of the company’s finances without getting bogged down in the details of an accounting report.

Let us use our previous example of XYZ, and compare it to another company, ABC. Company XYZ has a forward P/E of 20, while company ABC has a forward P/E of 10. Company XYZ has the highest forward P/E ratio of the two and this would lead most investors to expect higher earnings in the future than from company ABC (which possesses a lower forward P/E ratio).

As noted earlier, all P/E ratios are limited. They do not paint the entire picture for the investor; rather P/E is a complementary tool in your financial toolbox. Forward EPS measures are particularly perilous because they are matters of prediction and are only estimates of projected earnings.

Related Terms View All
  • Leasehold
    For example, let's say that Company XYZ leases a widget-making machine from Company ABC....
  • Greenwashing
    Let's say Company XYZ produces a new line of plastic food containers. It labels the...
  • Tax-Advantaged
    One of the best examples of tax-advantaged investing is the 401(k) plan. Offered by...
  • Obligation Bond
    The face value of an obligation bond is usually larger than the value of the property...
  • G7 Bond
    The G7 nations include the United States, Canada, the United Kingdom, France, Italy,...