Question

The Trailing Multiples or the Forward Multiple? which one is the best? Why?

What are the benefits of using the Earnings Multiple Method to determine the value of a target company?

Where should the analyst exercise caution when using the Earnings Multiple Method?

Should the results of the Earnings Multiple Method be used as the final determination of the value of the target company? Why? Or why not?

Answer 1

Question: The Trailing Multiples or Forward Multiple? Which one is the best? Why?

Sol: Let us first understand Trailing Multiples and Forward Multiples

Trailing Multiple: Trailing multiple is defined as the ratio of Price per share to the Earnings per share over the past 12 months.

Trailing Multiple or Trailing PE ratio = Price per share / Earnings per share over the past 12 months

Forward Multiple: Forward multiple is defined as the ratio of Price per share to the forecasted earnings per share over the next 12 months period.

Forward Multiple or Forward PE ratio = Price per share / Forecasted earnings per share over next 12 months

Note: In the above cases, current market price per share is to be considered for calculation.

From the above it is very clear that the primary difference between Trailing multiple and Forward multiple is the EPS (Earnings per share) used. For Trailing EPS we have used historical EPS and for Forward multiple we have used projected or expected EPS.

Now that we know the key difference between the multiples, EPS will have inverse relation with Forward and Trailing multiple. In other words, if EPS of the company is expected to grow, then the Forward multiple will be lower than the Trailing multiple.

Which among the two is best?

EPS of a company depends on the revenue of the company and how good the company's management is in achieving the set revenue targets for a particular year. Since Trailing multiple depends on the historical EPS, one will have a clear picture of the company's performance. Whereas in Forward multiple, one has to depend on the company's future performance, which is uncertain and depends on many external factors like economical conditions and internal factors like management. Therefore it is better to compare at least past three years performance of the company in achieving the set revenue targets and forecasted EPS to judge a company on Forward multiple. Also one might consider external and internal factors affecting the company's performance.

If in case a company has not achieved the past revenue targets, then it is better to judge a company on the Trailing multiple.