Forward P/E

A normal P/E ratio looks backwards: price divided by what a company has already earned. Forward P/E looks forwards instead: price divided by what analysts expect the company to earn.

The workbook is precise about which four quarters. A forward P/E for FY19 does not use FY19's own trailing numbers. It adds the estimated EPS for the four quarters that make up the FY19 year — say, June, September, December and the following March — and divides the current price by that total.

Formula (Chapter 3, section 3.5.3 A).

Forward P/E = Current market price ÷ Sum of expected next 4 quarters' EPS

Contrast this with trailing (historical) P/E, which divides by the last four quarters' EPS actually reported, and current P/E, which divides by the latest annual EPS.

Why bother with an estimate at all? A trailing P/E shows what the market paid for past earnings. A company whose earnings are expected to grow quickly can look expensive on a trailing basis and reasonable on a forward basis — the forward number prices in growth the trailing number cannot yet see.

The catch the workbook names as a limitation of forward P/E specifically: it relies on analyst estimates that may be inaccurate. A trailing P/E is arithmetic; a forward P/E is a forecast wearing arithmetic's clothes.

A private bank's shares trade at ₹950. Its last four quarters' EPS totalled ₹38, giving a trailing P/E of 950 ÷ 38 = 25.0.

Analysts expect the bank's loan book to grow faster next year and forecast the next four quarters' EPS at ₹47.50.

Forward P/E = 950 ÷ 47.50 = 20.0

On a trailing basis the bank looks expensive against an industry average of 22. On a forward basis, at 20.0, it looks cheap against the same industry average — if the ₹47.50 estimate holds. Six months later a slowdown in loan growth cuts the actual run-rate EPS to ₹42 for the year. Restated on realised numbers, the forward P/E an investor really paid was 950 ÷ 42 = 22.6 — still below the industry average, but not by nearly as much as the original estimate suggested.

Forward P/E is defined in Chapter 3 (Investing in Stocks), section 3.5.3 A, alongside trailing and current P/E, using the workbook's own FY19 illustration of adding four quarters of estimated EPS. Expect a question distinguishing the three P/E variants by which EPS figure sits in the denominator, and a conceptual question on why forward P/E is less reliable than trailing P/E.

• Forward P/E uses expected EPS for the next four quarters; trailing P/E uses actual EPS for the last four quarters. The two can disagree sharply for a fast-growing or fast-shrinking company.
• A lower forward P/E than trailing P/E signals the market expects earnings to grow; a higher forward P/E signals expected earnings to fall.
• The estimate can be wrong. The workbook lists inaccurate analyst estimates as a limitation specific to forward P/E, unlike trailing P/E, which is a matter of record.
• Do not confuse forward P/E's four-quarter estimate with current P/E's single latest annual EPS — current P/E does not forecast anything.