When should I use forward P/E versus trailing P/E in comparable analysis?

The choice between forward and trailing P/E depends on what you are trying to capture and the quality of available data.

Definitions:

• Trailing P/E = Price / Earnings per share over the last 12 months (LTM)
• Forward P/E = Price / Consensus forecast EPS for the next 12 months (NTM)

Key Differences:

When to Use Forward P/E (Generally Preferred):

1. Valuation is forward-looking by nature. You buy a stock for future earnings, not past ones. A company trading at 30x trailing but 18x forward may be fairly valued if earnings are accelerating.

1. Significant earnings change expected. If Oakfield Semiconductor (fictional) earned $2.00 LTM but consensus expects $3.50 NTM due to a product launch:

• Trailing P/E at $70 = 35.0x (looks expensive)
• Forward P/E at $70 = 20.0x (more reasonable)

1. Industry standard. Most sell-side equity research uses forward P/E as the primary metric.

1. Comparable analysis. When comparing peers, forward P/E normalizes for different fiscal year-ends and one-time charges in historical periods.

When to Use Trailing P/E:

1. No analyst coverage — small caps, micro caps, and some international stocks lack consensus estimates

1. Forecasts are unreliable — high forecast dispersion, turnarounds, or companies with volatile earnings make forward estimates questionable

1. Screening and historical comparisons — trailing P/E is useful for quantitative screens because it is objective and consistently calculated

1. Cyclical peak/trough detection — comparing trailing P/E to historical average trailing P/E helps identify where we are in the cycle

Practical Illustration:

Comparing three media companies at the same price ($50/share):

Using trailing P/E, Hargrove looks cheapest. But Hargrove's forward EPS is declining (margin pressure?), while Ridgeway is doubling. On forward P/E, Ridgeway is actually the cheapest.

Academic evidence: Research shows that forward P/E has better predictive power for future stock returns than trailing P/E, because it incorporates the most current information about earnings trajectory.

Exam tip: CFA Level II vignettes will often provide both trailing and forward data. If the question asks which metric is more appropriate for the given scenario, look for clues: anticipated earnings changes, one-time items in LTM earnings, or lack of analyst coverage.

Practice relative valuation in our CFA Level II question bank.