"If you like to buy companies on the cheap - like I do - you probably look at their P/Es. That's fine. Just know what you're looking at. If it's a forward P/E, ignore it. What's a forward P/E? Let me explain. Investors use P/E (price-to-earnings) ratios to measure how cheap a stock is. 'Value' investors love P/Es below 10 - meaning the price of a share is less than 10 times earnings per share. Since P/Es vary from sector to sector, some value investors simply look for P/Es that are below the average in their sector. A 'Ratios' report is available on the Reuters website for every listed company, and is the easiest way to look this up. To its credit, Reuters uses only 'P/E Ratio (TTM).' The TTM stands for 'trailing twelve months.' Other financial sites - including Yahoo - also give 'forward P/E.' This shows you what the company is expected to earn over the next year compared to its current price. 'Trailing' P/E and 'forward' P/E seem like close cousins, but they differ in one key respect. Trailing P/E is a real number. It records what has happened. There's no disputing it. On the other hand, forward P/E is just a guess. It's Wall Street's best estimate on what a company will earn in the future. By jacking up future earnings that haven't yet occurred, analysts can make a company look much cheaper than it is. Right now September, 2008], for example, some are projecting earnings to increase 70 percent this fourth quarter over last year's fourth quarter. And the chances of that happening are next to nothing. Forward P/E is least reliable when it's based on an economy that no longer exits. At a time like this, when the economy is undergoing a major shift - from growth to recession - you don't want to rely on analysts who are living in the past. "
Andrew M. Gordon
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