Understanding share prices based on "earnings forecasts"

theshortstack

Afternoon all - happy Wednesday!

While reading a number of articles over the course of the last few weeks, I've come across phrases such as "Company A is trading at just 12x earnings forecasts for the current financial year"

Can someone just explain to me what this earnings forecasts number means and how it's calculated? Also, it would be good to get an understanding (if applicable) of whereabouts this number needs to be for a stock to be considered 'cheap.'

Apologies for the noobie question, but thanks for your help - much appreciated!

Reaper

Earnings figures can come in one of two forms:

Past earnings (sometimes called "trailing") - the good thing about this is they are accurate. The bad thing is they tell you what happened to the company LAST YEAR, which may be completely different to what is expected to happen to it this year.

Forecast earnings - this tells you what the company is expected to earn in the future. More relevant but at the same time less accurate. If the figures are coming from an analyst report then the figures will be what that analyst expects them to be. You might also see the phrase "consensus earnings" which averages out what all the analysts think the figures will be.

P.S. On re-reading I think you are also asking what x12 earnings means. They will be referring to P/E (Wiki link) or Price/Earnings. This divides the share price by the earnings per share as a way of telling you whether the share price is cheap or expensive. The lower the P/E the cheaper it is - in theory. While useful it is an imperfect measure and doesn't give the whole picture by itself.

Your_Hero

Reaper's post sums it up nicely.

Essentially a P/E ratio measures how much an investor is willing to pay for the company’s current earnings and can also indicate investors’ expectations of growth. It also tells you how long it could take to recoup your initial investment based on earnings.

So if a company has a Forward P/E ratio (using the forecasted earnings in the next 12 months as opposed to historic earnings) of say 15, then based on expected earnings it would in theory take you 15 years to recoup the price you paid for that individual share.

P/E ratios have their limitations. An obvious one is that it can only really be used to compare with similar companies across the same sector.

theshortstack

Thanks for your time on this guys - appreciate your help!

IronWolf

Earnings forecasts used in forward P/E's are usually an average of all investment bank analyst forecasts that are covering the stock. Most of the time analysts are wrong

bigadaj

IronWolf wrote: »

Earnings forecasts used in forward P/E's are usually an average of all investment bank analyst forecasts that are covering the stock. Most of the time analysts are wrong

Most of the time?