Definition
Trailing Price-to-Earnings (Trailing P/E) is a valuation metric used in finance that compares the current market price of a company’s stock to its per-share earnings over the past 12 months. It’s calculated by dividing the current market price per share by the earnings per share (EPS) over the most recent 12-month period. This ratio helps investors or analysts to understand the relative value or profitability of a company.
Phonetic
The phonetics of the keyword Trailing Price-to-Earnings (Trailing P/E) would be:Trailing: ‘Trey-ling’Price-to-earnings: ‘Pryss – too – Ur-nings’P/E: ‘Pea – Slash – Ee’
Key Takeaways
<ol><li>Trailing Price-to-Earnings (Trailing P/E) is a valuation ratio, calculated by dividing the latest 12 months’ earnings of a company by its current market price per share. This ratio represents what an investor is willing to pay for each dollar of a company’s earnings over the past year. It provides a measure of the price investors are willing to pay for each dollar of the company’s earnings.</li><li>A lower Trailing P/E could suggest that a company is undervalued, but it could also indicate that the market expects the company’s earnings to decline in the future. Conversely, a high Trailing P/E might mean that a company is overvalued, or it could also suggest that the market is expecting the company’s earnings to grow. Thus, it’s important to compare the P/E ratios of companies within the same industry, or against the company’s own historical P/E.</li><li>It’s crucial to understand that Trailing P/E is based on past performance. It doesn’t take into account future earnings growth. As such, it might not accurately reflect a company’s potential. Some investors prefer to use the Forward P/E ratio, which is based on analysts’ forecasts for future earnings. Nonetheless, the Trailing P/E is widely used because it relies on actual, not projected, earnings.</li></ol>
Importance
The Trailing Price-to-Earnings (Trailing P/E) ratio is an important indicator in financial analysis since it provides insights into a company’s relative valuation. Trailing P/E is calculated by dividing the current market price of a stock by its earnings per share (EPS) over the past 12 months. This metric essentially reflects the dollar amount an investor is willing to pay for each dollar of a company’s earnings. The relative “expensiveness” or “cheapness” of a stock is thus encapsulated in the Trailing P/E. A lower ratio could be interpreted as a stock being undervalued (and therefore potentially a good investment), whereas a higher ratio could suggest overvaluation. It’s crucial to compare the P/E ratios within the same industry as they can vary greatly across different industries.
Explanation
The Trailing Price-to-Earnings (Trailing P/E) ratio is an essential benchmark that analysts, investors, and financial professionals use as a determinant to measure a company’s relative value and performance. This ratio provides insights about where a company stands in terms of profitability and earning power. The Trailing P/E comprises a company’s current share price divided by its earnings per share (EPS) over the past 12 months or the latest fiscal year. It essentially serves as a tool to quantify the dollar amount an investor can expect to invest in a company in order to receive one dollar of that company’s earnings.The practical purpose of the Trailing P/E is its use as a comparative tool to understand the relative costliness of stocks, where the lower the ratio, the cheaper the stock is considered to be. This can aid investors in making informed decisions about the purchase or sale of stocks based on their investment strategies. However, it is necessary to use the Trailing P/E ratio with other financial assessment tools and not in isolation, as it only provides a historical overview of the company’s earnings and not future performance. Therefore, in stock valuation and investment overview, it plays an instrumental role but should be used alongside comprehensive future-oriented analysis.
Examples
1. **The Apple Inc. Example**: As of August 2021, Apple Inc. (AAPL) had a trailing P/E ratio of around 28.54. It means that for every dollar of annual earnings, investors were willing to pay approximately $28.54. This trailing P/E ratio is calculated by dividing the most recent market price per share by the company’s reported earnings per share over the last 12 months.2. **The Amazon.com, Inc. Example**: As of August 2021, Amazon.com Inc. (AMZN) had a trailing P/E ratio of approximately 59.69. This indicates that investors were prepared to pay around $59.69 for every dollar that the company earned in the last year. This figure may suggest that investors have high expectations for the company’s future growth.3. **The Microsoft Corporation Example**: Microsoft Corporation (MSFT) had a trailing P/E of around 35.6 as of August 2021. This means investors were willing to pay $35.6 for every dollar of earnings the company made in the past year. Like other tech companies, this high P/E may reflect expectations for future earnings growth. Remember, each company’s trailing P/E can fluctuate with changes in share price and earnings. Also, comparing P/E ratios might be more useful within the same industry, as different industries can have inherently different P/E norms.
Frequently Asked Questions(FAQ)
What is Trailing Price-to-Earnings (Trailing P/E)?
Trailing Price-to-Earnings, or Trailing P/E, is a valuation ratio derived from a company’s current share price relative to its past, or trailing, earnings per share (EPS).
How is Trailing P/E calculated?
Trailing P/E is calculated by dividing the current market price of a stock by its trailing earnings per share (EPS) from the past 12 months.
What does a higher Trailing P/E ratio suggest?
A higher Trailing P/E ratio suggests that investors are anticipating higher growth in the future and are willing to pay a premium for it. However, a high P/E can also indicate that a stock is over-priced.
What does a lower Trailing P/E ratio indicate?
A lower Trailing P/E ratio could mean that a stock is undervalued, assuming the company is financially healthy and profitable. However, it could also indicate that the company has a slower growth expectation.
Why is the Trailing P/E ratio important?
The Trailing P/E ratio is a simple, straightforward measure of how a company is being valued by the market. It’s used to understand relative value, compare a company with its competitors, and assess market expectations for a company’s future growth.
How is Trailing P/E different from Forward P/E?
The main difference between the two is the earnings that they use. While Trailing P/E uses actual past (usually the last 12 months) earnings, Forward P/E uses projected future earnings.
What are the limitations of the Trailing P/E ratio?
The Trailing P/E ratio only considers past performance, which may not be a good predictor of future performance. It may also be distorted by a company’s one-off revenues or expenses. It doesn’t factor in other factors such as debt, assets, or growth potential either, and shouldn’t be used as a standalone tool for valuation.
Related Finance Terms
- Earnings Per Share (EPS)
- Current Market Price
- Financial Ratios
- Equity Valuation
- Stock Analysis
Sources for More Information
