The Motley Fool: P/E ratio vs. forward P/E ratio

Ask the Fool: P/E ratio vs. forward P/E ratio

Q: Should a company’s forward price-to-earnings (P/E) ratio be higher or lower than its current P/E ratio? S.B., Worcester, Massachusetts
A: Lower is typically better. A company’s current P/E ratio is its current stock price divided by its earnings per share (EPS) for the trailing 12 months so it’s backward-looking. The forward P/E ratio, in contrast, divides the stock price by next year’s estimated EPS.
A forward P/E ratio lower than the current P/E ratio reflects earnings that are expected to rise. Imagine, for example, that Buzzy’s Broccoli Beer (ticker: BRRRP) is trading at $100 per share with EPS over the past year of $4. Its P/E would be 100 divided by 4, or 25. If it’s expected to generate $5 in EPS next year, its forward P/E would be 100 divided by 5, or 20.
Of course, a lower forward P/E might just be due to unusually low earnings in the past year. And earnings estimates can turn out to be wrong. Never base any investment decision on only one measure, or even just a few.
Q: What does a company’s chief financial officer actually do? K.N., Chandler, Arizona
A: A chief financial officer (CFO) such as Microsoft’s Amy Hood, Merck’s Caroline Litchfield or ExxonMobil’s Kathryn Mikells is a top executive who manages the company’s finances. They determine the company’s current and future financial needs and plan how to most effectively meet them, handling relationships with banks and other funders. The CFO sets the company’s “capital structure” its mix of debt, stock and internal financing. And among other responsibilities, they oversee financial reporting, budgeting (which includes cash flow), tax issues and forecasting.

Fool’s school: Keep market drops in perspective

In early August, the stock market (as measured by the S&P 500 index, which tracks 500 of America’s biggest companies) dropped by 3% in a single day. That rattled many investors possibly including you.
By the time you read this, the market may have dropped further, or it may have recovered. It’s important to understand that no one can know what the market will do from day to day or even from year to year. That’s why you shouldn’t keep any money you’ll need within five, if not 10, years in the stock market: You don’t want to have to sell after a big drop. However, stocks are great for building wealth over many years.
Let’s put that 3% drop in context: Yes, the S&P 500 experienced a larger-than-usual decline, but even after that decline, it was still up some 9% since the beginning of the year. Even if all the year’s gains had been wiped out, that wouldn’t be unusual. Market drops are undeniably unsettling, but investors need to expect them. The market simply does decline now and then.
Drops of between 10% and 20% are referred to as corrections, while drops of 20% or more are generally called crashes. The stock market experiences corrections about every other year, on average, and crashes roughly every five or so years. (These are averages. The market might rise for, say, eight years in a row or drop for two years in a row.) The good news is that while the market can remain in a slump for years, it more typically bounces back from corrections within a matter of months.
Here’s more good news: When the market drops sharply, great stocks go on sale. Long-term investors with cash on hand can snap up bargains. As Warren Buffett has quipped, “(Investors) should try to be fearful when others are greedy and greedy only when others are fearful.”

My smartest investment: Held on for the win

My smartest investment move was holding onto my Lockheed (later Lockheed Martin) stock after working there from 1986 to 1999. I amassed some 800 shares and still have quite a bit today. J.D., Corralitos, California
The Fool responds: Holding on to shares of companies that are growing is often a very smart move indeed.
Lockheed Martin’s stock was recently up in value by 1,579% since the beginning of 1999, and that figure soars to 2,538% if you reinvested dividends. (Reinvesting dividends into additional shares of stock can be a powerful move.) That’s average annual growth of 11.6% and 13.6%, respectively well ahead of the corresponding respective returns for the S&P 500 index of 6.65% and 7.9%.
It’s worth noting that if these shares were a big portion of your portfolio while you worked at Lockheed, you were exposing yourself to meaningful risk. After all, your income was dependent on Lockheed, and much of your retirement nest egg would have been, too. Had the company hit a major rough patch, you might have lost your job and also taken a big hit in your portfolio at the same time. Investing in your employer can work out well, but it’s best to not overdo it.
(Do you have a smart or regrettable investment move to share with us? Email it to [email protected].)

Foolish trivia: Name that company

I trace my roots back to 1801, when an American patriot and Revolutionary War hero founded me outside of Boston as North America’s first copper mill. He was a silversmith who learned how to roll copper into sheets, which were used for cladding for ships. Multiple generations of his descendants worked in the business. Now based in Rome, New York, I’m one of the oldest manufacturing companies in the United States. In 2023, I opened a new plant in Mebane, North Carolina, in part to better serve the electric vehicle industry. Who am I?

Last week’s trivia answer

I trace my roots back to 1991, when I was conceived and referred to as “Honest Rick’s Used Cars.” I opened my first store with my current name in 1993 as a subsidiary of Circuit City. (I was spun off in 2002.) With a recent market value near $12 billion, I’m the largest used auto retailer in the U.S. In my last fiscal year, I sold about 770,000 used vehicles and 550,000 wholesale vehicles, while my finance division originated more than $8 billion in loans. I boast close to 30,000 employees and more than 240 locations across 41 states. Who am I? (Answer: CarMax)

The Motley Fool take: A Krafty proposition

Kraft Heinz (Nasdaq: KHC) is a profitable business that benefits from owning several top brands, including Capri Sun, Jell-O, Maxwell House, Oscar Mayer, Smart Ones, Velveeta, and its namesake Kraft and Heinz brands. Warren Buffett’s Berkshire Hathaway owns 27% of the shares outstanding, which puts shareholders in good company.
Sales have been weak lately, with many customers opting for less expensive items. But Kraft Heinz still generated $2.9 billion of free cash flow from over $26 billion in sales over the last year.
Kraft should return to growth, as it was reporting solid single-digit sales growth last year, and management expects a gradual improvement in the second half of the year. Plus, it’s innovating in new products.
Kraft Heinz’s dividend recently yielded a solid 4.7%. The company cut its dividend back in 2019 to strengthen its finances. But the steady sales from its strong brands and improved free cash flow should keep the dividend safe from further cuts.
Moreover, the stock trades at an inexpensive forward-looking price-to-earnings (P/E) ratio of 11.2, below its five-year average of 13. As Kraft pays down debt and returns to growth, the stock could offer an upside that, combined with a high yield, could lead to handsome returns in the coming years. (The Motley Fool recommends Kraft Heinz.)

— distributed by Andrews McMeel Syndication

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