Peter Iwanowicz's  Instablog

I recently read an article (here) by Jeremy Seigel the Ph.D. economist who currently teaches at UPenn, about how Standard & Poors computes its coveted 500 Index’s Earnings Per Share. Believe it or not, S&P calculates EPS of the index on a simple sum basis. Meaning if every company earned $1.00/share, the Index will have earned $500/share.

Dr. Seigel proposed that S&P switch how it computes its EPS to a market weighted summed, similar to how it calculates the price of the Index. I agree with this methodology and strongly disagree with S&P’s response to why it currently uses its current method.

To mirror Seigel’s example and to build on it, let’s assume we have an index of two stocks, AIG and ExxonMobil, and that they each make up 50% of this index. If you were to model this index, regardless of size, for every share of AIG stock you purchase you will also purchase an ExxonMobil share. Suppose AIG incurs heavy losses and posts huge negative EPS numbers, while XOM posts huge profits and large EPS numbers.

            During 2007, equity markets were in love with the agriculture boom and related stocks began to price in this investor sentiment. However, many pundits laughed at the idea of a food shortage and that one was far too Draconian of an event to occur.

            However, I believe that the case for food shortages is real and that this impending issue will cause the value for goods and services that increase the efficiency in the production of grain and meat to increase.