EPS Forecasts Portend Positive Market… Sort Of

If the consensus earnings estimates coming out of Standard & Poor’s and “the Street” (via Thompson Reuters) are realistic, then it looks pretty good for a stable to rising market value. We say value instead of prices, because price and value don’t always coincide.

At 923 the S&P 500 is about 12 times the 2010 $74.10 forecast for the S&P 500 operating earnings by Standard and Poor’s, or the $74.48 forecast by “the Street” according to Thompson Reuters. Barron’s reports a Capital IQ survey of six strategists’ forecast of $68.45 for 2010, making today’s 923 index price about 13.5 times 2010 operating earnings.

Actual S&P 500 operating earnings in 2007 and 2008 were $82.54 and $49.51. That puts $74 at almost 90% of the 2007 earnings level — quite an amazing and surprising expected accomplishment given all we’ve been through.

S&P forecasts $55.61 operating earnings in 2009 for the S&P 500, while “the Street” forecasts $58.52.

There are more negative thoughts out there, however, such as Barclay’s Capital which sees $46 in 2010, which would put the S&P 500 at about 20 times operating earnings in 2010.

A multiple of 12 is attractive, while a multiple of 20 is not generally attractive, unless you can construct an argument for higher valuation based on low interest rates, but then you have to predict lower rates and interpret multiple years of lower rates as not an indication of terrible economic conditions.

You have to decide whether these numbers are realistic. We’ve heard one strategist call them “wishful non-thinking”. Robert Shiller refers to “spontaneous optimism” and “animal spirits”, neither of which sound similar to “rational analysis”.

Therein lies basic choices you must make. Do you invest based on proven history (wait for the results) or on predictions made by others with methods, conflicts and biases not disclosed? Do you invest on rationalized value or actual market price behavior? Do you assume things have always worked out in the past and will again, or do you assume there are long-term structural changes in the economy that will create an adverse shift in the profits and growth curve thereby suppressing values and prices?

In terms of predictions made by others, here are the 2009 and 2010 percent changes in operating profits by sector for the S&P 500 from Standard and Poor’s analysts and from Thompson Reuters for “the Street”.

click images to enlarge

One of the difficulties using brief reports of earnings as are typically available in the financial press is that the numbers are disembodied. They lack adequate historical context to be fully helpful.

Standard and Poor’s does a good job of providing context. We have extracted data from a three of their reports and combine them in the following image. While the format is different, all of the data is their data (except for some ratios based on their data that we calculated and show in blue).

The data is for the index and each of its ten sectors.

The table in the image shows past, present and projected operating earnings and “as reported” earnings, and P/E ratios based on the June 23 index price. The data includes annual data and comparative data for Q1 for each year. The percentage change between periods is also shown.

Large Image 1305 X 925 pix

One thing about the forecasts in particular bothers us. The ratio of “as reported” to operating earnings is not good even in 2010 — much worse than in 2007. If the index is still losing big, big bucks, the value of rising operating earnings is a little squishy. Yes, it suggests good things someday, but when — and when are we supposed to take risks with our own capital betting that “one time losses” or “extraordinary losses” will stop offsetting operating profits?

Ratio of “as reported” to operating earnings:

• 2007: 75.6%
• 2008: 30.1%
• 2009: 51.5%
• 2010: 51.0%

Looking briefly beyond the large-cap universe of the S&P 500, let’s see what Standard and Poor’s has to say about the mid-cap S&P 400 and small-cap S&P 600.

S&P 400 Operating Earnings:

• 2007 $42.65
• 2008 $30.04
• 2009 $27.65
• 2010 $40.53 (13.68 forward P/E)

S&P 600 Operating Earnings:

• 2007 $18.99
• 2008 $10.22
• 2009 $10.18
• 2010 $17.46 (14.72 forward P/E)

Related ETFs: SPY, IVV, MDY, IJR

Disclosure: We may own any of these securities from time-to-time in managed accounts.

Comments

[Fred Voetsch:]

"You have to decide whether these numbers are realistic."

No, Richard, we do not, because your numbers are not relevant.

Even though you touch on the discrepency between operating and as-reported earnings you make the same old mistake of using operating earnings as your primary earnings even though operating earnings have no historic relevance. NONE.

The average P/E of 15 is based on REPORTED EARNINGS.

The "overpriced" P/E of 20 is based on REPORTED EARNINGS.

The "underpriced" P/E of 10 is based on REPORTED EARNINGS.

You are using operating earnings to apply a P/E ratio to an entire index...

"At 923 the S&P 500 is about 12 times the 2010 $74.10 forecast for the S&P 500 operating earnings by Standard and Poor’s..."

...and that is not how operating earnings should be used.

Operating earnings are a way to normalize reported earnings and mainly should be used on a company-by-company basis or perhaps on a sector, if there were special circumstances such as the huge write-off for banks recently.

To blindly apply them to a whole index is nothing short of incompetence, but sadly, this not unusual these days.

People who make these mistakes are generally the same people who couldn't see this debacle coming and who won't see the next one either.

Now back to my checkbook...let's see, if I consider this debt as "special" and that foreclosure notice as a "one time write-off" and add in the tax rebate I'll get next April I'm really in pretty good shape. Yeah, that's the ticket!

Jul 02 09:09 PM

[Fred Voetsch:]

BTW, I can easily make a case for the S&P 500 at 120 using REAL DATA.

If earnings stagnate at $20 and we apply a historic low P/E of 6 we come up with the S&P at 120.

Very simple, very historically relevant, very possible.

Jul 02 09:12 PM

[Richard Shaw:]

Fred,

Your are a tiresome bore. If you don't like my writing, then stop reading and it if you read it and wish to comment, then actually read it and comment on what I said not what your superficial reading causes you to think I said.

None of the data in this site, or any of the P/E's come from me. They came from S&P or Thompson Reuters. If you think they are doing it wrong then write to them. Barrons published the Reuters data. If you think they are stupid too, then write them.

If you bothered to even read the title, and noticed the "... sort of" ending you might have had the ability to see my expression of doubts about the predictions. However, that is probably too subtle for someone with as blunt and unartful style of commenting as your own.

Also if you had bothered to read the article you would not that it provides P/E for both operating earnings and "as reported" earnings, not just operating earnings as you complain.

Your consistent attack mode on my articles using terms like "nonsense" and "irrelevant", and your condescending tone is unbecoming, and as you can tell frankly pisses me off.

How you could possibly effectively tell me I am stupid for accumulating and reporting data published by S&P and data from
Thomspon Reuters and published by Barron's is simply beyond my imagination.

Get a life!

Richard Shaw

Jul 02 10:12 PM

[BigJake:]

well said Richard. I have gained alot of knowledge reading about techniques you have described in your article. Fred, not to knock the content of your post which is valid could have been stated a bit more respectfully. Just because its the internet doesn't mean we can check our couth at the door

Jul 02 10:49 PM

[No Free Cake:]

The "As Reported" vs "Operating" earnings debate is a good one. I realize Operating is a more recent creation and thus lacks a direct historical comparison. But, accounting rules have also changed over time making "As Reported" earnings inherently different. Siegel has said that his S&P sources say that Operating earnings are closer to the historical As Reported earnings for this reason. Take that for what it's worth. I would surely like to see a good article about that.

Fred, even the famed Nouriel Roubini, who did in fact "predict" this melt-down, uses aggregate earnings and historical multiples to project S&P 500 Index levels.

Jul 05 12:38 AM