Overview on Trailing P/E Ratio
The sole aim of investing in the stock market is to earn profits. Additionally, investors prefer equity investing compared to traditional investments like fixed deposits and savings accounts because of higher returns. When you invest in stocks or equity, you become a part-owner in those businesses in the proportion of the shares purchased, without any required active involvement in the company. This also means that if the company makes a profit, it shares a part of its earnings with you as the investor.
There are many metrics involved in checking a company’s profitability. One important metric to an equity investor is Earnings Per Share (EPS). A company’s earnings on a per-share basis constitute EPS. An investor can determine earnings per share in various forms, but to check the most recent EPS, the trailing earnings per share is a good measure. This article details what trailing earnings per share is in detail.
What is Trailing Earnings Per Share (EPS)?
The Trailing earnings per share meaning is the company’s earnings on a per-share basis as a rolling total over a prior period, usually a financial year. The “trailing” here indicates a value calculated on a rolling basis. To break it down,
Trailing refers to the tracking (the past 12 months);
Earnings refer to the net income;
Per Share refers to each outstanding share.
I.e., Tracking the past 12 months’ net income of the company for each outstanding share.
According to the trailing earnings per share definition, the net income considered to calculate it at any point in time is taken for the past 4 quarters or 12 months.
Trailing Earnings Per Share is a ratio indicative of a company’s profitability in the recent year. The higher the Trailing EPS of a company, the more profitable it is, i.e., more appealing to an investor.
This measure is entirely based on historical earnings figures and does not indicate any potential future earnings. Trailing EPS allows the scope of trend analysis of a company’s profitability over the period. Let’s say the third quarter witnesses more sales due to the festive season of Diwali and Durga Puja. This would be more important for a retailer. For analysts, quarter three is important to compare the year-on-year (YoY) changes while simultaneously comparing the trailing earnings per share for these periods.
It is crucial to note that the Earnings Per Share (EPS) of a company is not necessarily the profit share that you will get for every stock you hold. EPS can be re-invested in the business to grow it, or it may be distributed to the shareholders as dividends.
This earnings potential shall reflect in the company’s price. This is where the Price to Earnings (PE) ratio becomes important.
Importance of Price to Earnings
The Price to Earnings (PE) ratio indicates the price investors are ready to pay for Rs. 1 of the EPS of the company. This helps understand if a company is overvalued or undervalued. A PE ratio of 20 indicates the time taken for accumulated earnings to level the price of the investment.
A high PE ratio means that the price of the stock is more than its EPS. This could mean that the shares of a company are expensive and might fall in the future.
The Trailing Price to Earnings (PE) ratio is the relationship between the stock price of a company and its trailing earnings per share. This metric determines the market value of a company’s stock compared to its Trailing Earnings Per Share (EPS).
The accuracy of the trailing price to earnings ratio is considered more as it provides a more realistic result as it includes accurate parametric figures.
Example of Trailing Earnings Per Share (EPS)
For example, the quarterly financial results for the year 2021-22 (FY22) of a company reveal the earnings per share as
- INR 3.78 in Quarter I
- INR 4.01 in Quarter II
- INR 3.32 in Quarter III, and
- INR 3.09 in Quarter IV
These would generate the trailing earnings per share of INR 14.2 at the end of FY22.
Now, if the results for Quarter I FY23 stands at INR 3.95, the new trailing EPS would be INR 15.06 at the end of Quarter I FY23. Quarter I of FY 22 is dropped off the calculation as soon as the newer figures are released.
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Frequently Asked Questions
Ans: Trailing EPS is based on historical and actual earnings for a particular period, whereas the forward EPS takes future earnings into account through forecasting techniques.
Ans: Higher trailing EPS means greater value. If the company had to distribute the whole of its earnings as a dividend, each shareholder would have got the higher amount in absolute terms.
Ans: Yes, trailing EPS is also referred to as the Trailing Twelve Month EPS or TTM EPS.
Ans: Trailing PE ratio provides the market value of a company as compared to its earnings for a particular period. A higher PE ratio generally means the company’s stock is expensive, and the price of it is likely to fall. A lower PE ratio might mean the company is trading cheap, and the price of it would increase gradually.
Ans: No, PE ratio alone as the base investment decision-making metric would be a bad choice. There are many factors determining the stock prices, and high or low PE doesn’t always indicate whether it would be expensive or cheap.
Ans: Apart from the earnings per share of a company, other factors affecting the PE ratio are earnings stability, dividends, return on invested capital, and interest rates.