A fundamental analyst may use the forward P/E (forward price to earnings )to calculate the value of a stock. This ratio is similar to the P/E (price to earnings) ratio but it uses the projected estimated future earning of the company.

Formula

The P/E ratio looks to see how expensive a stock is and how much stock investors are willing to pay for each dollar of earnings. A forward P/E does the same thing except it looks at how expensive a company is by using the estimated projected earnings of the company and not historical earnings.

Forward P/E Ratio = Price per share/ Forward Earnings Per Share

Example

Company A has a share price of $25.00, earnings per share is $0.74, and estimated earnings growth of 15%.

The Price to earnings ratio would be =$25/$0.74 = 33.69x

The forward price to earnings ratio would be = $25/($0.74*1.15) = 29.37x

Comparing companies

Forward P/E ratios are used to compare companies in the same industry. This will give the investor an idea of how expensive this company is compared to others in the same industry.

As the stock market is forward looking, it would be more accurate to use the forward P/E ratio to evaluate companies. However, as these future earnings are only estimates, these figures produced by analysts or company executives could be incorrect.

Lauren Hua is a private client adviser at Fairmont Equities.

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