Over thought, and now I am confused. When we are computing the justified Trailing or Leading P/E ratio, and we want to decide where the stock is, over or undervalued, one way is to multiply the Trailing P/E to E0 or current earning or trailing earnings, and the Leading P/E to Leading earning or forward earnings…right ? Assuming I am correct in my statement above, my question is: Is the intrinsic value based on Leading or Trailing the same? if not, which one will we consider when we attempt to determine whether the stock is over or undervalued? I hope that made sense. Thank you.
Really, it’s the leading justified P/E ratio that is the attempt to get at intrinsic value, and essentially, it all depends on whether your estimates of E1 are any good or not. If you have a mature, dividend paying company with a constant growth rate, that’s a reasonable way to do it, but everything else ends up being about whether your estimates of future growth are anything reasonable. The advantage of the trailing P/E ratio is that Trailing E is more-or-less observable and doesn’t depend on what assumptions the analyst is making about future earnings growth. In that sense, it’s more objective. There are two problems with the trailing P/E, though, which is 1) that E0 may not be very useful in predicting what E1 is, and investing is all about future performance, not past performance (except to the extent that you can make sensible guesses about future performance from past performance data), and 2) even E0 can be a bit subjective if you are adjusting financial statements for different depreciation methods, extraordinary expenses, etc…