Sunday, November 2, 2008

More on S&P 500 Earnings

More on earnings from Barron's. The article will probably be free tomorrow or Tuesday. If you want it now let me know and I can email it.

Talk about out of touch: Analysts currently estimate that earnings for the companies in the S&P 500 will rise 29% in the fourth quarter, and keep climbing, by 15% in 2009, to a record $91.41 a share, according to Thomson Reuters. That seems wholly unrealistic, given the recent jump in unemployment, the credit crisis and last week's news that the economy contracted at a 0.3% annual pace in the third-quarter.

The analysts may be asleep on the job, but the markets certainly seem to be anticipating a sharp drop in corporate earnings.


Five prominent strategists we polled last week expect earnings for the S&P 500 to fall 15% this year and 3% next year, to roughly $70 a share.

If the strategists are right, stocks are pretty fairly valued right now. The S&P 500 was trading Friday at 960, or 13.7 times the strategists' $70 earnings estimate for 2009. For the past 30 years, stocks have traded at an average of 13.7 times expected earnings. So 13.7 times depressed earnings seems pretty reasonable.

What I referenced earlier:

"We believe the analysts' numbers will come down considerably," says Howard Silverblatt, senior index analyst at Standard & Poor's. As of now, S&P's own analysts are calling for $94 of earnings for the S&P 500, while S&P's economist expects only $62.40.


Let's say that S&P companies earn only $60 a share next year, which is Merrill Lynch's top-down estimate. Apply the same historic multiple of 17.82, and the index would be valued at 1069 -- about 11% above Friday's level.

The risk: In past recessions, earnings multiples have fallen well below the average. In the 1975 recession, the market's trailing P/E sank to 7.28, and in the 1980 downturn it shrank to 6.84. A seven multiple applied to $60 of earnings would result in the S&P 500 trading for only 420 -- 50% below current levels. That's something we hope never to see.

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