Halal Investment Series Part 16
If you ask an investor to name the most popular stock market metric other than price, the price to earnings ratio (P/E) -Trailing P/E and Forward P/E- is likely to come to mind. The P/E ratio is not only the most well-known indicator of an equity’s true value as well as remarkably simple to calculate.
The trailing PE calculates the price-earnings ratio using the company’s earnings per share over the previous 12 months. The forward PE calculates the price-earnings ratio using the company’s forecasted earnings per share over the next 12 months.
The price to earnings (PE) ratio assesses the relative value of corporate stocks, determining whether they are undervalued or overvalued. It is calculated as the ratio of the current share price to earnings per share.
Investors calculated Forward P/E ratios using future earnings guidance rather than trailing figures. This forward-looking indicator, also known as “estimated price to earnings,” is useful for comparing current earnings to future earnings. Furthermore, it provides a clearer picture of what earnings will look like without changes and other accounting adjustments. However, the forward P/E metric has inherent flaws, such as companies underestimating earnings in order to beat the estimated P/E during the announcement of the next quarter’s earnings. Other companies may overestimate the estimate and then adjust it in their next earnings report. Furthermore, external analysts may provide estimates, which may or may not be accurate.
Forward PE Ratio Formula = Price Per Share / Forecasted EPS over the next 12 months
To calculate the trailing P/E ratio is by dividing the current share price by the total EPS earnings over the previous 12 months. Many investors and analysts used the P/E ratio because it’s the most objective, assuming the company reported earnings correctly. Because they don’t trust other people’s earnings estimates, some investors prefer to look at the trailing P/E ratio. However, trailing P/E has some drawbacks, one of which is that a company’s past performance does not predict future behavior. As a result, investors should make investments based on future earnings potential rather than past performance. Another issue is that the EPS number remains constant while stock prices fluctuate. If a major company event causes the stock price to rise or fall significantly, the trailing P/E will be less reflective of those changes.
Trailing PE Ratio Formula (TTM or Trailing Twelve Months) = Price Per Share / EPS over the previous 12 months.
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