Are you an investor who likes to buy companies on the cheap?
If this is so, then you probably look at their P/Esprice-to-earnings ratios… and that’s OK, but make sure you know what you’re looking at.
In a few words, if you see a forward P/E, disregard it.
Why do we say this?
Well, because basically investors use P/Es to measure how cheap a stock is, and “value” investors adore P/Es below 10, this is, when the share’s price is less than 10 times earnings per share.
But P/Es vary among sectors and some value investors just look for P/Es that are below average in their sector.
The easiest way to look this up is through the “ratios” report that is available on the Reuters website for every listed company. This source uses only the P/E Ratio (TTMTrailing Twelve Months).
Other financial websites also give the ‘forward P/E’, which shows what a company is expected to earn over the next year in comparison to its current price.
The ‘trailing P/E’ and the ‘forward P/E’ may seem very similar; however, there is an important difference between them:
- The ‘trailing P/E’ is a real number. It records what has already happened; thus, it can’t be doubted.
- The ‘forward P/E’ is basically a guess. It is the best estimate on what a business will earn in the future. If analysts boost future earnings they can make a company look much cheaper than it really is.
A ‘forward P/E’ is less reliable when it is based on an economy that is long gone, and in current times, when the economy is uncertain, you should not trust analysts who live in the past.
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