What is forward price-to-earnings?

Analysts often use forward price-to-earnings (P/E) ratio as a form of valuation metrics that incorporates estimated future earnings. Here we take a look at the forward price-to-earnings meaning to understand the valuation technique in more detail. 

Similarly to the standard P/E, forward ratio is a fundamental analysis tool that aims to establish how overvalued or undervalued  a company’s stock might be. Forward P/E uses estimated earnings per share (EPS). 

It may provide biased results should estimations significantly differ from the actual results. Analysts therefore tend to combine forward and trailing P/E for a realistic valuation. 

How to Calculate forward P/E

As a form of the P/E ratio, forward price-to-earnings calculation uses estimated earnings per share. Therefore, the forward P/E formula is derived from the standard P/E equation. 

To calculate forward P/E divide a share’s current price by predicted future earnings per share (EPS). Analysts often provide their EPS estimates for a fiscal year ahead, or you can find their total earnings estimates and divide them by the number of outstanding shares.

For a better understanding of what forward price-to-earnings means, let’s take a look at an example. Let’s say a company's current stock price is $25. Analysts estimate an EPS of $1.50 for the next quarter. It’s forward P/E ratio would be 25/1.5=16.

Difference between forward P/E and trailing P/E

The key difference between standard P/E and the forward price-to-earnings definition is that the former uses actual EPS that has already been reported by a company, whereas the latter uses the EPS estimate. 

Analysts use the two ratios for different purposes. The standard P/E ratio is used to evaluate whether a company is overvalued or undervalued, whereas forward P/E ratio determines future estimated value. 

For instance, if the current price of a stock is $8 with the EPS of $1, and its earnings are expected to double in the next year to $2, the forward P/E ratio will be 4x, or half of the company’s value when it earned $1. 

If the forward P/E is lower than the current P/E, analysts expect earnings to increase. Similarly, when the forward P/E is higher than the current P/E ratio, analysts expect earnings to decrease.