P/E vs Forward P/E: Which is Better for IPO Valuation?

Trailing Earnings vs Future Projections

When analyzing IPO valuations, you will frequently encounter two variations of the P/E ratio: Trailing P/E and Forward P/E. Trailing P/E is calculated using the company's historical earnings over the past 12 months. It is based on hard, audited facts. Forward P/E, on the other hand, uses projected earnings for the next 12 months, which are essentially educated estimates provided by management and analysts.

While Trailing P/E tells you exactly where the company stands today, Forward P/E gives you a glimpse into its future growth trajectory, which is crucial for pricing new issues.

Why Growth Companies Use Forward P/E

Fast-growing startups and tech companies often look extremely expensive (or even have negative P/E ratios) based on historical trailing data because they reinvest all their cash into growth. Lead managers pitch these IPOs using Forward P/E to justify the high issue price, arguing that upcoming profits will rapidly normalize the valuation.

If institutional investors buy into these future projections, the real-time IPO subscription data will show massive QIB inflows. If the projections look too optimistic or fake, the issue will struggle to get subscribed.

Influence on Bidding and Allotment

Retail investors often get trapped by misleading Forward P/E projections that never materialize post-listing. If you base your bidding solely on aggressive future estimates, you risk buying an overvalued asset.

Always base your core decision on trailing numbers. If you do apply, make sure to check IPO allotment status promptly. If the allotment is successful but the broader market suddenly crashes, high Forward P/E stocks are usually the first to suffer severe corrections on listing day.

Choosing the Right Valuation Metric

For stable, dividend-paying companies (like FMCG or banking), Trailing P/E is the safest metric. For high-growth SaaS or EV companies, Forward P/E is necessary, but requires a pinch of skepticism. Always cross-check the market's belief in these projections by looking at the Kostak rates and Subject to Sauda. A strong GMP indicates that the street actually believes the management's future earnings guidance.

The Dangers of Optimistic Projections

During the IPO roadshow, lead managers paint a rosy picture of the future to justify a high Forward P/E. If the company misses its quarterly earnings estimates post-listing, the market violently punishes the stock, resulting in a severe crash. Always take forward projections with a grain of salt.

How Analysts Estimate Forward Earnings

Analysts build complex DCF models, factoring in expanding profit margins, new product launches, and reduced debt costs to estimate future earnings. However, these models cannot predict black swan events, regulatory changes, or sudden shifts in consumer behavior.

Sector-Specific Valuation Norms

You cannot use P/E universally. For capital-intensive sectors like Telecom or Infrastructure, analysts prefer EV/EBITDA. For banking and NBFC IPOs, the Price-to-Book (P/B) ratio is the ultimate metric. Using Forward P/E on a bank is generally considered a flawed valuation approach.

Why Trailing P/E is Safer for Retail

Retail investors lack the sophisticated tools and inside access required to verify management's future projections. Relying on Trailing P/E ensures you are paying for actual, audited performance rather than dreams. It acts as a natural margin of safety against overpriced tech IPOs.