What Is Trailing Price-to-Earnings?
Let me explain trailing price-to-earnings (P/E) directly: it's a relative valuation multiple based on the last 12 months of actual earnings. You calculate it by taking the current stock price and dividing it by the trailing earnings per share (EPS) for those past 12 months.
You can contrast this with the forward P/E, which uses projected future earnings instead to figure out the ratio.
Key Takeaways
The trailing price-to-earnings ratio examines a company's share price in the market relative to its earnings per share from the past year. It's a useful indicator for standardizing and comparing relative share prices across different time periods and among various companies. However, while trailing P/E is widely used, it has limitations because past earnings might not accurately reflect the company's current or future earnings situation.
Understanding Trailing Price-to-Earnings
The price-earnings ratio, or P/E ratio, comes from dividing a company's stock price by its earnings from the most recent fiscal year. When people talk about the P/E ratio in general, they're usually referring to the trailing P/E. You get it by dividing the current market value, or share price, by the EPS over the previous 12 months.
You'll find the earnings for the most recent fiscal year on the income statement in the annual report. At the bottom, there's a total EPS for the entire fiscal year. Divide the current stock price by this number to obtain the trailing P/E ratio.
The formula is straightforward: Trailing P/E Ratio = Current Share Price / Trailing 12-Month EPS. This measure is reliable because it's based on actual performance rather than expectations. That said, a company's past earnings aren't always a good predictor of future ones, so you need to approach it with caution.
Why Do Analysts Use P/E?
Analysts rely on the P/E ratio because it provides an apples-to-apples evaluation of relative earnings. You can use it to spot relative bargains in the market or to identify when a stock is overpriced compared to others. Some companies warrant a higher P/E multiple due to stronger economic moats, but others with high prices relative to earnings are just overvalued. Similarly, some firms deserve a lower P/E as they represent a great deal, while others have a low P/E due to underlying financial weakness. Trailing P/E helps match time periods for a more accurate and current measure of relative value.
One disadvantage is that stock prices fluctuate constantly, while earnings stay fixed. To address this, analysts use the trailing P/E, which incorporates earnings from the most recent four quarters instead of just the last fiscal year's end.
Example of Trailing Price-to-Earnings
Consider a company with a stock price of $50 and 12-month trailing EPS of $2; that gives a trailing P/E ratio of 25x, meaning the stock trades at 25 times its trailing 12-month earnings.
If the stock price drops to $40 midway through the year, the new P/E becomes 20x, so the price is now at 20 times earnings, even though earnings haven't changed—just the price has.
If earnings for the last two quarters have dropped, you can substitute the first two quarters of the fiscal year with the most recent two for the trailing P/E. If those recent quarters show lower earnings, the P/E will be higher than 20x, indicating the stock might be overvalued at the current price given the declining earnings trend.
Trailing vs. Forward P/E
Trailing P/E differs from forward P/E, which uses earnings estimates or forecasts for the next four quarters or the next 12 months. As a result, forward P/E can sometimes be more relevant for investors evaluating a company. However, since it relies on estimated future earnings, it's susceptible to miscalculations or analyst bias. Companies might also underestimate or misstate earnings to beat consensus estimates in quarterly reports.
Both ratios come in handy during acquisitions. Trailing P/E indicates the past performance of the company being acquired, while forward P/E reflects future guidance. Valuations are typically based on the forward ratio, but buyers can use an earnout provision to reduce the acquisition price, with an option for additional payout if targeted earnings are met.
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