Blended P/E

The most important thing to understand about P/E ratios or any other metric ratio (price to cash flow, price to EBITDA etc.) is that there is no such thing as an accurate one.  The reasons are simple.  The P/E ratio is expressed as a fraction where P (price) is the numerator and E (earnings) are the denominator.

In other words, the P/E ratio is a mathematical formula simplistically expressed as a ratio of price divided by earnings.  Price (the numerator) is generally accurate because it is based on current data and often calculated in real time.  Price is current because it is being reported virtually every minute of every trading day.

In contrast, earnings (the denominator) are only reported 4 times a year (quarterly).  To make matters worse, it usually takes approximately 45 days after a fiscal quarter closes for the company to prepare and have the financial statements audited before they are publicly reported.  Therefore, the earnings number that the price is being divided by is both stale and inaccurate.  By the time you see the earnings number, half of the next quarter is already over.  As a result, P/E ratios are at best approximates and not perfectly accurate calculations.

Moreover, when you see P/E ratios reported on various financial sites and quoting services, you will some sites utilizing trailing twelve months earnings (ttm) while others will utilize forward earnings based on estimates.  Once again, trailing twelve months’ numbers are stale as described above, and the forward earnings are best guesses about future earnings.

Consequently, FAST Graphs attempts to provide a more accurate expression of the P/E ratio through the utilization of a blended calculation.  The FAST Graphs blended P/E ratio (metric multiple) is based upon a weighted average of the most recent actual value and the closest forecast value.  However, we also recognize that the blended P/E ratio is not precisely accurate either.  Nevertheless, we believe it is logically more accurate than utilizing trailing twelve month or forward earnings forecasts.  Therefore, we feel it is the best way to calculate and present the P/E ratio.

To understand the blended P/E ratio more clearly, you can perform a simple mathematical exercise where you solve for E (earnings).  Simply take yesterday’s closing price on your FAST Graph and divide it by the blended P/E ratio.  This will tell you the actual level of earnings that the P/E ratio (multiple) is being calculated upon.

If you then look at the bottom of the graph where earnings are reported (EPS) you will note that the earnings number you calculated will be between the last actual earnings number and the next forecast number, which is an estimate and is marked with a capital “E”.  In other words, the calculated earnings are a blend of past, present and the closest forecast earnings.

Further Explanation: Why P/E Ratios Are Reported Differently On Various Financial Websites

Why are the P/E ratios different on other financial websites compared to FAST Graphs? There are several factors that will cause financial websites to report different P/E ratios.

For starters, you must be cognizant of the specific earnings metric that is being utilized. Many sites will utilize diluted (GAAP) earnings when they do the calculation. FAST Graphs defaults to “Adjusted (Operating) Earnings.” However, “Diluted Earnings (GAAP)” are available with FAST Graphs along with two other metrics: “Basic Earnings” and “Owner’s Earnings.” We also offer calculations based on Cash Flow or FFO and AFFO for REITs. The following is describing the FAST Graphs blended P/E ratio. This approach is utilized with all the metrics that FAST Graphs offers.

To summarize, different sites may be reporting P/E ratios based on a different earnings metric than what you see on the FAST Graph.  Therefore, even though different, they can all be correct depending on which type of earnings are being utilized.

Nevertheless, one of the simplest and most commonly used ways to determine the value of a publicly-traded business is by checking the company’s P/E ratio. The formula is very simple, it is simply the current price (P) divided by earnings (E).

At first glance, this seems simple enough, but often it is not as simple as it appears.  As described earlier, the company’s stock price is reported in real time on most financial websites that offer a quoting service. But businesses only report earnings on a quarterly basis. Consequently, when we are between the quarterly reports, we really don’t have a precise earnings figure upon which to calculate the P/E ratio.

As a result, not all financial websites report the P/E ratio on the same basis. Some will report P/E ratios based on trailing twelve month earnings (ttm), others might report the P/E ratio based on forward earnings, and some will report P/E ratios on both.

Unfortunately, this can lead to a common mistake that is often made when looking at a P/E ratio on a quoting service. The price or numerator (the top number) is current and accurate. However, it is the earnings or the denominator (the bottom number) that can be problematic. If you are using trailing earnings (ttm), your denominator might be too small, thereby causing the P/E ratio to be higher than it really is.

If you are using forward earnings, they might not manifest as expected, thereby causing the denominator to be too large, which makes the P/E ratio calculation look lower than it truly is. Consequently, FAST Graphs calculates the current P/E ratio by taking a blended approach. Admittedly, like the trailing or forward calculations, a blended P/E ratio might not be perfectly accurate either. However, we do believe that a blended P/E ratio calculation will be more precise than the two other alternatives.

Remember, trailing twelve months’ earnings can be getting stale, especially when we are in the late innings of the next quarter. Earnings estimates out to the next year may be too optimistic. However, giving credit to the current quarter’s earnings estimates are more likely to be realistic or close to it. Here it is important to again note that it takes companies approximately 45 days after the close of the fiscal quarter before the actual numbers are reported. Consequently, it is possible that a trailing twelve month number might be 4 ½ months old. Therefore, by blended P/E ratio, we mean a weighted average of the most recent actual reported earnings plus the closest quarterly forecast earnings.

This gives the most weight to the past “actual” reported earnings, but also includes an appropriate consideration of the company’s continuing earnings power post their last report. For most companies, the blended P/E ratio calculation will be using a moderately higher denominator than trailing twelve months. In other words, we believe the blended P/E ratio calculation is based on a more accurate or precise current level of earnings.