someone emailed me this....for you S&P guys and calls...(from briefing.com)
S&P 500 P/E Now 26.2, or 23.5 if You Prefer
Daily commentary updated for March 09, 1998
Earnings estimates are dropping, and stock prices are rising. That is pushing valuations
through the roof.
Earnings Data
The table below presents earnings data for the S&P 500 from 1997 and earnings
estimates for 1998 as of March 5.
1997
1998
Estimated % Gain
As Reported
40.25
45.83e
13.9%
Top Down Operating
44.87
48.47e
8.0%
Bottom Up Operating
44.87
49.79e
11.0%
Notes: 1997 As Reported (including all charges and gains) data from S&P, all others from
First Call. Operating numbers exclude one-time charges and gains. Bottom up is the sum
of individual company estimates, top down a macro-based estimate.
Given a closing value of 1055.69 on the S&P 500 on Friday, March 6, this leaves
the price/earnings (P/E) ratios as follows:
As reported trailing 12 months P/E = 26.2
Operating earnings trailing 12 months P/E = 23.5
Year ahead (1998) operating earnings top-down P/E = 21.2
Using any of these measures, the P/E is at extremely high levels.
As Reported vs. Operating Earnings
In recent years, the stock market has come to accept a wider definition of what should be
excluded from earnings data in terms of determining the value of a company.
The simple fact is, any one-time charge or loss is a very real accounting event that
decreases the value of a company. When a company takes a charge for acquisition
costs, excess inventory, discontinued products, or whatever, it is always a negative event
and often reflects bad management decisions. It is not a good thing.
Yet, the stock market prefers to completely ignore these items and instead look at
"operating income." The theory is that operating income reflects the future prospects for
the company and the "real" operations of the company. Behind this assumption, though
rarely noted, is that there will be no more future, recurring, one-time charges that also cost
the company (and shareholder) money.
A better way of looking at one-time charges, in fact, is to view them as costs to the
company over a period of time. Ignoring them altogether simply denies they exist. In the
case of a single company, it might make sense to virtually ignore one-time charges because
looking at them over an extended period would have little impact. One-time charges for a
company that does not regularly engage in taking charges can generally be ignored.
However, when aggregating 500 companies, the one-time charges should not be
ignored. Across a universe of 500 companies, "one-time" charges occur each quarter with
regularity. They are, in effect, recurring costs to the aggregated companies. Acquisition
costs, inventory write-offs, and bad decisions occur on a regular basis for the overall S&P
500. They are a cost of doing business.
Rose Colored Glasses
It used to be common to assess the earnings for the S&P 500 in terms of the "as
reported" numbers, the honest-to-God real numbers that companies posted, taking in all
the good with the bad. This still makes sense but is not commonly done anymore.
Instead, the market now vastly prefers valuation based on operating income. After
all, no one ever seems to care what one-time charges on individual companies reflect, they
just want to know whether XYZ Corp. "beat by a penny" or came in "as expected," so
why should anyone care in the aggregate. And, it makes current valuation levels at least a
little more reasonable.
P/E's Sky High by Historical Standards
Either way though, the current valuations are very high. On an as-reported basis, the
market P/E is now over 26. On an operating basis, it is over 23. This compares to a
historical P/E on as reported numbers of about 17 or less for many decades, and to one
old rule of thumb that the market P/E should be 20 less the rate of inflation.
Of course, there is widespread belief that there is a new paradigm, that the old
measures just don't matter anymore.
Money is still money, however, and investments still need to provide a rate of
return. No matter what paradigm is fashionable this week, the return on investments is still
a function of future profits, and the discounted present value of those future profits based
on an inflation/interest rate assumption. This reality raises red flags for those concerned
with valuation.
Earnings Projections Plummeting
As noted in Yesterday's Brief, first quarter earnings estimates are falling fast. Even before
the Intel, Motorola, and Compaq warnings, the consensus estimate for first quarter
year/year earnings had fallen to +3.7% from about 15% as recently as early January.
Give it a few weeks and the number could be getting disturbingly close to zero.
Even more worrisome is the fact that the current earnings weakness is not all Asian related.
There may also be a slowdown in earnings momentum from the U.S., based on
Disney, Intel, and Compaq statements.
Investors apparently believe that the current earnings slowdown will be
temporary, as has almost all bad news the past few years. If so, then maybe earnings will
start growing at 15% a year in the second half of the year. That is what investors are
apparently pricing stocks on now.
If that changes, however, and a belief develops that earnings growth will slow for
several years, then the market is at serious risk.
Old Paradigm Still has Value
We have heard all the arguments: "where else are people going to put their money,"
"buying on dips is the key to investing," etc., etc. That certainly has been true the past few
years. But now, for those who still like to look a little deeper, the slowdown in earnings
and rising P/E's are very troubling. During the rally of the past three years, a slowdown in
earnings growth like this has not occurred, and P/E's have not reached this height.
Eventually, earnings do matter, and the warnings from Intel, Compaq, and others,
should be heeded in light of the high market valuations. |
