The price-earnings (P/E) ratio is one of the fundamental metrics for measuring the relative value of a stock. It tells you what you, as an investor, are paying for every dollar the company books on the bottom line. If you can buy those profits cheap, a stock may be a bargain. If you have to pay a premium, you need to ask yourself why. But there are two P/E ratios to be found attached to every stock: current and future. And they're frequently more than slightly different.
In this segment of the Market Foolery podcast, host Chris Hill and senior analyst Abi Malin offer some guidance to a listener who's trying to figure out why the two measures may disagree, what it reflects, and which of the two is more useful.
A full transcript follows the video.
Check out the latest earnings call transcripts for companies we cover.
This video was recorded on Feb. 11, 2019.
Chris Hill: Question from Matt McIver, who asks, "Is there anything to be gleaned from comparing Current P/E to forward P/E? Am I correct in reading the tea leaves that a lower forward P/E is a bullish indicator?" Thank you, Matt, for the question!
So, when you're looking at current price to earnings ratio vs. forward price to earnings ratio... ?
Abi Malin: I think the big factor here is what you're comparing. Current P/E is current price over current earnings. Forward P/E is the current price over the expected earnings per share. When forward P/E is less than future P/E, it indicates that there is a projected increase in earnings per share, but that can be done by an increase in earnings and/or usually some combination of stock buybacks.
I would say it's an optimistic signal, but I think the thing to keep in mind here is that analysts have to be right. That's an expectation. If they beat expectation, that's where you really see the opportunity. If they miss expectations, even if it's above what it currently is, you're still going to see some fluctuation to the downside. Keep in mind that that's an expectation and not a set projection.
Hill: Do you have one that you rely on more than the other as a working analyst?
Malin: I look more at current price to current earnings as it compares to major competitors and the player, trying to get a value sense between Company A and Company B when they both compete in the same sector.