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Strategies & Market Trends : John Pitera's Market Laboratory -- Ignore unavailable to you. Want to Upgrade?

To: X Y Zebra who wrote (4644)	9/20/2001 8:20:45 PM
From: John Pitera	Read Replies (2) \| Respond to of 33421

This Withering Bear Valuation post by Carl Swelin, shows how richly valued the market still may be decisionpoint.com ---------------- Some prior posts on Pro forma earnings: Message 16312029 Few investors know it, but the U.S. stock market today is, by one way of looking at it, the most expensive it has ever been. How could that be, after the numbing slide since the market peaked in early 2000? It turns out that for all the pain, the stock market now is far out of whack with historical norms by one common measure, the price-to-earnings ratio. The P/E ratio measures how companies' share prices compare with their profits, showing how much value the market places on each dollar of a company's earnings. The lower the P/E, as a rough rule of thumb, the cheaper the stock. Though this guide to value has lots of exceptions, it remains a venerable market benchmark. The Standard & Poor's 500-stock index of large companies, according to Thomson Financial/First Call, finished last week with an overall P/E ratio of 22.2. While that is well above the long-term historical average of 14.5, it strikes some pros as reasonable in view of factors such as low interest rates and chances for a profit comeback. For instance, Edward Kerschner, chief global market strategist at UBS Warburg, recently called stocks "undervalued on a P/E basis." But there's a catch. In recent years, P/E ratios have become increasingly polluted. The "E" in P/E used to refer simply to earnings as reported under generally accepted accounting principles, or GAAP. That's what it means when the historical average is cited. But in First Call's figure, the "E" relates to something fuzzier, called "operating earnings." And that can mean just about whatever a company wants it to mean. Based on earnings as reported under GAAP, the S&P 500 actually finished last week with a P/E ratio of 36.7, according to a Wall Street Journal analysis. That is higher than any other P/E previously recorded for the index. (See details of the calculation2.) Message 16267166 Message 16263049 ================================================= Carl's missive on Proforma Earnings..................... REAL P/E IN PERSPECTIVE I learned something today that completely shocked me. I have long been aware of the lie called "pro forma" earnings that are reported by companies every quarter. This is where the company disregards expenses they simply would rather not report because they are considered to be not representative of normal operating costs. The whole process has only been used in recent years and is meant to mislead investors regarding the true earnings picture of the company. What I didn't know is that these "cooked" results are actually "booked" by reporting organizations like First Call and also by the media, so when you read in Barron's that the S&P 500 P/E is 25, it is based on these phony numbers, not on actual earnings based on GAAP (Generally Accepted Accounting Principals). According to an article in the August 26, 2001 Wall Street Journal, the P/E for the S&P 500 for the most recent quarter based on GAAP was about 37, not 26 as was reported in Barron's this week. I was curious as to how our P/E chart would look based on a P/E of 37. See above for the sorry result. In my opinion it supports my assertion that the stock market bubble does exist and to a much greater degree than even I had thought. This does not, of course, mean that people won't continue to ignore value and bid the market higher -- I still hear reputedly rational people claiming that the market is undervalued -- but it is overvalued by any reasonable measure. The disparity between price and earnings can be corrected by (1) a price correction that brings prices in line with earnings, (2) earnings increases that bring earnings in line with prices, or (3) a combination of the two. History teaches us that bubbles normally result in price corrections, not value increases, because valuation bubbles far exceed reasonable, sustainable growth rates. Recent examples are the Nikkei since its 1989 top and the Nasdaq since its 2000 top. The arrows in the margin of the above chart reflect estimates for a price correction, assuming no change in current earnings. Increased earnings would move those arrows higher. I will continue to publish this chart based on the phony numbers, because that's all we have readily available, but I thought some of you would want to see the harsh reality. By the way, every time I highlight this chart I get mail from people explaining to me how it's different this time. We dinosaurs are incapable of understanding such logic, so please don't bother. --Carl Swenlin