Trailing pe ratio

What Is Trailing PE Ratio?

The Trailing PE Ratio, also known as the Price-to-Earnings (P/E) Ratio (TTM for "trailing twelve months"), is a widely used metric in stock valuation that measures a company's current stock price relative to its earnings per share over the past 12 months. This ratio is a core component of fundamental analysis and helps investors gauge how much they are willing to pay for each dollar of a company's past earnings. As a key indicator within stock valuation, the Trailing PE Ratio provides insight into market sentiment and a company's perceived value based on its historical profitability.

History and Origin

The concept of relating a company's market price to its earnings has long been central to assessing an investment's value. While the precise origin of the "Price-to-Earnings Ratio" as a formalized metric is not tied to a single invention, its widespread adoption and standardization evolved with the growth of modern financial markets and the increasing need for consistent corporate financial reporting. The formalization of accounting standards and regulations, such as those overseen by bodies like the U.S. Securities and Exchange Commission (SEC), significantly contributed to the consistent availability and comparability of financial data, making the calculation and use of metrics like the Trailing PE Ratio more feasible and widespread. Public companies are required to file detailed financial statements that underpin such calculations.

Key Takeaways

The Trailing PE Ratio divides a company's current share price by its earnings per share over the previous 12 months.
It serves as a primary tool for stock valuation, indicating how much investors are willing to pay for a company's past earnings.
A higher Trailing PE Ratio often suggests that investors anticipate higher future growth, while a lower ratio might indicate a more mature company or a potentially undervalued stock.
The Trailing PE Ratio is most effective when compared against the company's historical ratios, industry averages, or competitors.
It reflects historical performance and does not account for future earnings expectations, which can be a limitation for certain analyses.

Formula and Calculation

The formula for the Trailing PE Ratio is straightforward:

\text{Trailing PE Ratio} = \frac{\text{Current Share Price}}{\text{Earnings Per Share (EPS) for the Past 12 Months}}

Where:

Current Share Price: The current market price of one share of the company's stock. This is the prevailing stock price at which the shares trade on an exchange.
Earnings Per Share (EPS) for the Past 12 Months: The total earnings per share generated by the company over the last four fiscal quarters (trailing twelve months, or TTM). This figure is derived from the company's financial statements.

Interpreting the Trailing PE Ratio

Interpreting the Trailing PE Ratio involves more than just looking at a single number; it requires context. A high Trailing PE Ratio suggests that the market has high expectations for the company's future growth and is willing to pay a premium for its earnings. This is often seen in growth stocks, where investors prioritize future potential over current income. Conversely, a low Trailing PE Ratio may indicate that the market has lower expectations for future growth, or that the stock might be undervalued. This is more common with value stocks or companies in mature industries.

For meaningful analysis, the Trailing PE Ratio of a company should be compared to its own historical average, the average for its industry, or the ratios of its direct competitors. For instance, a technology company might consistently trade at a higher Trailing PE Ratio than a utility company, reflecting different growth trajectories and risk profiles across sectors.

Hypothetical Example

Consider Company A, a publicly traded entity, with the following financial data:

Current stock price: $50 per share
Earnings per share (EPS) for the past 12 months: $2.50

To calculate the Trailing PE Ratio for Company A:

\text{Trailing PE Ratio} = \frac{\$50}{\$2.50} = 20

A Trailing PE Ratio of 20 means that investors are currently willing to pay $20 for every $1 of Company A's earnings over the last year. If a competitor, Company B, has a Trailing PE Ratio of 15, and both operate in the same industry with similar growth prospects, this might suggest that Company A is relatively more expensive or that the market has higher expectations for Company A. Investors would then conduct further fundamental analysis to understand the discrepancy.

Practical Applications

The Trailing PE Ratio is a cornerstone metric for investment decisions across various financial applications:

Stock Screening: Investors often use the Trailing PE Ratio to screen for potential investments, identifying companies that appear relatively expensive or inexpensive compared to their earnings.
Comparative Valuation: It is frequently employed to compare the valuation of publicly traded companies within the same industry or sector. For example, financial analysts regularly publish reports comparing the Trailing PE ratios of peers. The P/E ratio for a company like Thomson Reuters, for instance, can be tracked historically to observe its valuation trends over time.⁴
Mergers and Acquisitions (M&A): In M&A deals, the Trailing PE Ratio can be used as a quick benchmark for the initial pricing of target companies.
Market Analysis: Economists and market strategists often analyze the aggregate Trailing PE Ratio of major market indexes (e.g., S&P 500) to assess overall market valuation levels and potential over or undervaluation. Understanding how the P/E ratio is used by financial professionals is crucial for comprehensive market insights.³
Regulatory Filings: The underlying earnings per share data used in the Trailing PE Ratio calculation is sourced from mandated public disclosures, such as those found on the SEC's EDGAR database. These filings provide transparency and allow investors to verify the financial information used in their analysis.²

Limitations and Criticisms

While widely used, the Trailing PE Ratio has several limitations that savvy investors consider:

Backward-Looking: The ratio is based on historical earnings, which may not be indicative of future profitability. Companies facing significant changes in their business environment, such as new competition or economic shifts, may have past earnings that do not reflect their current or future prospects.
Volatility of Earnings: Earnings can be volatile, especially for companies in cyclical industries or those undergoing restructuring. A single period of unusually high or low earnings can skew the Trailing PE Ratio, leading to potentially misleading investment decisions.
Accounting Practices: Differences in accounting standards and methods can affect reported earnings, making direct comparisons between companies challenging. Non-GAAP earnings, which exclude certain expenses, can further complicate interpretation, potentially making a company appear more profitable than it is under Generally Accepted Accounting Principles (GAAP).¹
Negative Earnings: If a company has negative earnings (a loss) over the trailing 12 months, its Trailing PE Ratio will be negative or undefined, rendering the metric useless for valuation purposes. This is common for many nascent or rapidly growing growth stocks that are not yet profitable.
Industry Differences: Comparing Trailing PE Ratios across different industries can be misleading due to varying business models, capital intensity, and growth rates. What is considered a "high" or "low" ratio can differ significantly from one sector to another.

Trailing PE Ratio vs. Forward PE Ratio

The Trailing PE Ratio and the Forward PE Ratio are both forms of the price-to-earnings ratio used in valuation, but they differ significantly in their time horizons. The Trailing PE Ratio uses a company's historical earnings per share (EPS) from the previous 12 months. This makes it based on actual, reported data, offering a concrete look at past performance. In contrast, the Forward PE Ratio uses estimated future EPS, typically for the next 12 months. This makes it a forward-looking metric that reflects market expectations about a company's future profitability. While the Trailing PE Ratio offers certainty due to its reliance on historical figures, the Forward PE Ratio provides a perspective on anticipated growth and is favored by investors looking to factor in future prospects, though it carries the inherent risk of estimation inaccuracies.

FAQs

What does a high Trailing PE Ratio mean?

A high Trailing PE Ratio suggests that investors are willing to pay a premium for a company's earnings per share from the past year. This typically indicates strong market confidence in the company's future growth prospects, often seen in high-growth industries or growth stocks.

Is a low Trailing PE Ratio always good?

Not necessarily. While a low Trailing PE Ratio might suggest a potentially undervalued stock or a value stock, it could also indicate that the market anticipates declining future earnings, significant risks, or that the company is in a struggling industry. Further fundamental analysis is essential to understand the reasons behind a low ratio.

How often does the Trailing PE Ratio change?

The Trailing PE Ratio changes constantly as the company's stock price fluctuates during trading hours. The "earnings per share (TTM)" component typically updates quarterly when the company releases its new financial statements, incorporating the latest four quarters of earnings.

Can the Trailing PE Ratio be negative?

Yes, the Trailing PE Ratio can be negative if a company has negative earnings per share over the past 12 months, meaning it incurred a net loss. In such cases, the ratio loses its interpretive value for valuation and other metrics might be more appropriate.