Our trailing price-to-earnings multiple rates as a curiosity. Yet there it is. The beloved “trailing P/E” ratio is what we mean. Stare at a car–any car. The driver’s seat in all cars symbolizes proper stock thinking. Orientation displayed? Forward. Check the relative size of the rear view mirror when compared to the windshield. That’s a clue. Of course we want to know the backgrounds of both company and stock. Yet change is relentless, as are the demands of shareholders.
Ask these three questions, for each of the companies in which you hold stock: what does the sub-industry look like now? How does your company view that future? What are they doing to create that future? First sources for this information are conference calls. Conference calls are found on the company website, in webcast format. Seeking Alpha, NASDAQ, and others also offer call transcripts, the written text. Listen to the call for tone and emphasis. Read the transcript for study.
Only a mad cow pilots a portfolio primarily focusing on trailing data. That includes the ubiquitous trailing P/E. Instead? Focus forward. It’s fundamental.
The forward P/E ratio is an estimate. One direct fact resides behind this yet key number. Estimates of future earnings rely on past earnings. Companies have track records. GOOG earned $12.31 a share in 2016. Estimates for 2017 GOOG earnings stem from that foundation.
Stock analysts scan a company’s various income streams. They factor for shifts in circumstances, inside or outside of the company. Crunch income streams results in a total revenue estimate. To reach an earnings estimate one factors for management effectiveness; past gross and net margins, return on invested capital(ROIC), return on equity(ROE), and long term debt to equity. Other good metrics exist.
Forward P/Es are like bread. Analysts bake their own. Estimates are like dough. They rise like dough. Sometimes they’re over-baked.
Estimates are “arrived at.” Price targets are arrived at, sometimes alone and at night. Who wishes to stand totally alone in a public way concerning a widely-held stock? In all fairness, the predicting business is tough in every way. Predicting is of course tough by nature. Stock predicting by higher-profile analysts is also complicated.
Stock analysts work for people. Those people are often big financial firms. These firms almost without exception have brokerage, or stock trading, wings. The largest customers of such brokerage divisions are “institutional” investors. Institutional investors are groups like “sovereign wealth funds,” or nations, CALPERS, the California state retirement fund, or a fund family such as Vanguard. Therein lies the problem.
The voice of the equity analyst exists within a context beyond stock fundamentals, or technicals. Remember Darth Vader ceaselessly prowling the CIA prior to the Iraq war?
Amazon triggers a price target raise nearly every quarter. What does that say about estimating? Estimating stock price moves involves both work and intuition guided by market knowledge and experience. Find sources that empower and inform your efforts. Listen first to the company, and judge what it says against its’ own record. We love “Mad Money.”
Forward P/E ratios are estimates, made by people. Look for the “consensus” estimate, a combination of many opinions.
One base and direct fact informs the forward P/E. Annual earnings. Forward P/E ratios are estimates directly based on the company’s actual earnings over the trailing 12 months. Those actual earnings are on the record and viewed by investors as predictive. History matters. Past earnings clearly demonstrate earning capability. Yet circumstances change, and so do any actual earnings. That’s one reason we call them “estimates.”
Using the consensus analysts’ forward P/E provides a fairly good look into the ever changing future of a company, and your stock.
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