Forward PE is a Lie

Edit: While this post certainly applies at the individual company level, ***this post is more aimed at the index level***. It's typically pretty easy to make the proper adjustments when looking at single company. Less so when looking at 500 companies, all weighted differently, in an index. To start off, Forward PE seems to have gained steam recently, I think, because it gives a "warm and fuzzy" about valuation prospects - looking at the next twelve months (NTM) earnings makes stocks feel less overvalued than they actually are because our subconscious compares NTM PE to trailing PE. In reality, we should be comparing like for like - either Forward PEs across time or trailing PEs across time...but never Forward PEs vs Trailing PEs... But that's not even the biggest issue. ***Forward PE estimates are non-GAAP!*** The first clue is that forward PEs should build from a foundation of trailing numbers - NTM PE should be a function of TTM PE & next year's earnings growth rate. But in reality, when we look at a TTM PE number of 27 and a NTM PE of 20, the implied growth rate is 35% - *not realistic in the slightest.* The earnings estimate used don't include stock based compensation (SBC) or one-time items. The problem with the former is that SBC is a real cost to shareholders (via dilution) and the latter will understate earnings across a large sample. If you're looking at the earnings trend for a single company, it makes sense to back out one-time expenses. But for a large group of companies, there will always be one-time expenses...again, this isn't like-for-like when comparing against trailing PE numbers. It's also not indicative of true valuation to exclude real costs to the business. SBC is an even bigger deal while in a correction. If a software engineer's total comp is $125k and $25k of that is SBC, what happens when the stock goes down? The company has to issue more shares to cover that compensation, which means more dilution to shareholders. In this sense, lower prices actually lowers the value of the company. So when you hear someone say ***"Sure, trailing PE is close to 27, but the forward PE is 20"*****, be careful.**