Forward Price-to-Earnings Ratio
What It Is:
The forward price-to-earnings ratio (forward) is a valuation method used to compare a company’s current share price to its expected per-share .
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, may not be as intuitive for most investors. The more traditional and widely used version of the calculation comes from the previous four of the , called a trailing . Another variation of the EPS can be calculated using a forward P/E, estimating the 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 . Calculated as the following;
Forward Price-to-Earnings Ratio (P/E) = Market value per share / Forward
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 of 20, while company ABC has a forward of 10. Company XYZ has the highest forward ratio of the two and this would lead most investors to expect higher in the future than from company ABC (which possesses a lower forward ratio).
As noted earlier, all ratios are limited. They do not paint the entire picture for the investor; rather is a complementary tool in your financial toolbox. Forward measures are particularly perilous because they are matters of prediction and are only estimates of projected .