There are three ways to look at price to earnings ratios, or P/E ratios. You can look at P/E ratios based on last year’s earnings, forecasted earnings, or a ten year average of earnings.
1. P/E Ratio Based On Last Year’s Earnings
This calculation takes current price of the market divided by last year’s corporate earnings. The problem with relying on this calculation is the possibility that next year will be nothing like last year; corporate earnings could me much higher, or much lower.
2. P/E Ratio Based On Forecasted Earnings
This calculation takes the current price of the market divided by an average of all of the forecasted earnings put forth by analysts and the companies themselves. The problem with this calculation is there are numerous occasions where forecasted earnings are not accurate.
That is what makes the market so difficult to evaluate. No one truly knows what will happen next year. A lot of smart people make forecasts; some will be right and some will be wrong.
3. P/E Ratio Based On A Ten Year Average Of Earnings
This calculation takes the current price of the market divided by corporate earnings as averaged over the past ten years. This ratio is called P/E 10 and the method was developed by Professor Robert Schilling. It is designed to even out the inconsistencies that can come from using only one year of past or projected earnings data. (By Dana Anspach)