Research Articles

3 Consecutive Double-Digit Years for the S&P 500?

Julie C - Sunday, January 09, 2011
The question posed by the title of this article is whether or not 2011 will be the third year in a row of double-digit returns for the S&P 500. In calendar year 2009 the S&P 500 returned 26.4% and followed this up in 2010 by earning 15.06%. As we look forward to 2011 we see a distinct probability based on current consensus earnings estimates that the S&P 500 could increase an additional 11% - 13% this year. This would mark the third year in a row that the S&P 500 generated double-digit returns.
The following F.A.S.T. Graphs™ on the S&P 500 provides the current bottoms up operating earnings estimate of $94.80 from Standard & Poor's Corporations website. If you multiply the $94.80 earnings estimate by an 80 year historical PE ratio of 15 for the S&P 500 you get an implied value of 1422. This is approximately 11% - 12% higher than the current value based on the 1273.85 level of the S&P 500 on January 6, 2011. Importantly, this is offered as a forecast of intrinsic value based on the S&P 500 reaching these earnings targets and being capitalized at a historic normal PE ratio.
Benjamin Graham on the past and future of common stocks
Courtesy of ValueHunter we were given the privilege and opportunity of reviewing a compilation titled Common Stock Investing: the papers of Benjamin Graham written by Benjamin Graham. As most readers probably know Mr. Graham is considered the father of modern security analysis. Furthermore, he has served as the mentor to some of the most famous and renowned disciples of value investing to include Jean-Marie Eveillard, Warren Buffett, William J. Ruane, Irving Kahn, Hani M. Anklis and Walter J. Schloss, to name just a few. One of Mr. Graham's most famous, and we feel priceless, tidbits of wisdom is his often quoted:” the market is a voting machine in the short run and a weighing machine in the long run” metaphor.
In his compilation of papers mentioned above, Ben Graham provided similar insights about the stock market that we had not come across before but wanted to share. In one paper he talked about the past and future of common stocks as follows:

Before I came down to Wall Street in 1914 the future of the stock market had already been forecast-once and for all-in the famous dictum of J.P. Morgan the elder: it will fluctuate. It is a safe prediction for me to make that, in future years as in the past, common stocks will advance too far and decline too far, and that investors, like speculators-and institutions, like individuals-will have their periods of enchantment and disenchantment with equities.

The point of the above quote is simple, thanks to often irrational investor behavior by individuals and institutions alike, the stock market and stock prices can and will be mispriced from time to time. But Mr. Graham taught those of us wise enough to listen that inevitably stock prices would move to sound valuation based on fundamentals. Therefore, wise investors would recognize misappraisal (over or under), when it occurred and make rational long-term investment decisions accordingly.
Although the actual determination of intrinsic value is part art and part science, and therefore, cannot prudently be expected to be calculated with absolute precision, determinants of intrinsic value can be made with enough precision to be valuable.
In the past we've written about how any investment inevitably receives its value from the amount of cash flow it is capable of generating for its stakeholders. Regarding applying a fair value to those cash flows, we have previously discussed how even a no growth income stream, like those produced from fixed income securities such as a bond, would always have a value greater than one times its income stream. We used this logic to illustrate the validity behind the historical 15 PE ratio that has traditionally been awarded to the S&P 500, or common stocks in general. In the same papers mentioned above, Mr. Graham provided the following insight: "It seems logical to me that the earnings/price ratio of stocks generally should bear a relationship to bond interest rates."
Conclusions
From the F.A.S.T. Graphs™ of the S&P 500 above, several observations are made clear. Most important of all, is the long-term correlation between earnings and stock price. In other words, prices will tend to move with earnings, and whenever they get disconnected from each other they will converge or revert to the mean. The 14-plus years covered in the above graph provide strong evidence of the validity of the 15 PE ratio. This is even more relevant when you consider the anomalous period of overvaluation described by the infamous label "irrational exuberance." Since 1997 the S&P 500 has not fallen below this 15 PE level except for very brief points of time. Therefore, we suggest that a fair value calculation of future S&P 500 earnings is reasonable at a PE of 15.
Much will continue to be written about what's going on with the economy: interest rates, employment levels, debt levels, inflation and on and on. Yet it becomes very clear that at the end of the day that it all comes down to earnings. The last two years of strong performance in the S&P 500 was almost completely overshadowed by dire forecasts of pending doom and gloom. Consequently, few investors were able to enjoy the prosperity that has followed the great recession. The adage that "Wall Street climbs a wall of worry" could be modified to Wall Street clawed and scratched its way up a head wall of extreme pessimism.

We intend to update the S&P 500 F.A.S.T. Graphs™ and earnings estimates each quarter. To repeat our position, we believe that earnings drive market price in the long run. Therefore, whatever level of earnings the S&P 500 ends up generating by year-end 2011 should be a major determining factor of what level this important index ends the year at.

In February of 2010 we presented the following article: “S&P 500: A 20% rise in 2010?” dated February 21, 2010. You may find it interesting to revisit this article in order to see how relevant it was. The main difference was that we utilized the 20-year historical S&P 500 PE of 17.5 instead of the 80-year historical S&P 500 PE ratio of 15. This higher PE ratio was skewed because of the irrational exuberance that we previously mentioned. You will also notice that the current S&P 500 earnings per share for 2010 are higher than estimated in our February article.

Disclosure: I have no positions in any stocks mentioned, and no plans to initiate any positions within the next 72 hours. The opinions in this document are for informational and educational purposes only and should not be construed as a recommendation to buy or sell the stocks mentioned or to solicit transactions or clients. Past performance of the companies discussed may not continue and the companies may not achieve the earnings growth as predicted. The information in this document is believed to be accurate, but under no circumstances should a person act upon the information contained within. We do not recommend that anyone act upon any investment information without first consulting an investment advisor as to the suitability of such investments for his specific situation.

Comments
Post has no comments.
Post a Comment




Captcha Image

{tag_blogid}
Trackback Link
http://www.fastgraphs.com/BlogRetrieve.aspx?BlogID=419&PostID=239159&A=Trackback
Trackbacks
Post has no trackbacks.

Dividend Champions*

Live F.A.S.T. Graphs can be activated by clicking on one of the links below, which includes most Premium graphing options:
=> Get LIVE FAST Graphs (MSFT)
- - - - - expires: 02/13/2013  - - - - -
=>Get LIVE FAST Graphs (AAPL)
- - - - - expires: 11/29/2012  - - - - -

Testimonials

“I appreciate your work, Chuck. As a subscriber to FAST Graphs™, I use the tool to decide on whether to purchase additional shares of what I currently hold or to add a new holding. Your articles help me make full use of the tool and give other readers valuable information, if they take the time to learn. One of the biggest enhancements that I use is the FFO data added for MLPs and REITs.”


“When FAST Graphs™ were unavailable because of Hurricane Sandy, I realized how much I need them in order to make investment decisions.

(Wish I could be) Long FAST Graphs!!!”


“One more vote for the value of FAST Graphs™; just started a subscription to Chuck's great service (premium), and am having a ball analyzing so many stocks quickly.”


“I feel very ill-equipped to make investment decisions without Fast Graphs. :-)”


“Yesterday, I signed up for your F.A.S.T. Graphs™. It's a really amazing, valuable tool for checking over/undervaluation of stocks. Wish I had it years and years ago!!”


“Love the F.A.S.T. Graphs™: One glance and you know a whole lot.”


“About Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


"Chuck -- Your proprietary F.A.S.T. Graphs™ are a VERY impressive tool!"


“If there were an Investor Hall of Fame for people who have helped others with their investing, and sharing valuable information, you and your F.A.S.T. Graphs™ would get one of my selections.”


“I love Chuck's F.A.S.T. Graphs™! Well worth the price of admission for what he gives you.”


"Chuck - Thank you for your well thought out articles. I tend to be a visual type of person so I really appreciate the F.A.S.T. Graphs™ approach."


"Great article, as always! I always look forward to your articles, and am especially eagerly awaiting your next in this series. I find the F.A.S.T. Graphs™ extremely helpful."


“Your F.A.S.T. Graphs™ put all of this in a single artful picture and the accompanying spreadsheets hammer home the point.”


“I use the F.A.S.T. Graphs™ method to evaluate all of my ideas. I recommend it for individual investors, since it helps them focus on data and get past the many emotional arguments.”


“I recently subscribed to the F.A.S.T. Graphs™, and these articles are helping me learn how to better use them. They really do give you a good quick look at the valuations picture. A much needed tool!”


“I also always appreciate the clear-cut information provided through your F.A.S.T. Graphs™ and articles.”


“Thanks, Chuck, for your F.A.S.T. Graphs™. Each of these graphs is worth 1,000 words in describing a company's growth, consistency and valuation. Thanks for sharing your graphs.”


“Thanks, Chuck. Love the F.A.S.T. Graphs™! It makes investing so much more clear.”


“Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


”I am amazed at the usefulness of your F.A.S.T. Graphs™ and I plan on using them for a long time to come.”


“Chuck's F.A.S.T. Graphs™ will give you a tool to find those well chosen stocks...”


“Thanks for the F.A.S.T. Graphs™, Chuck. They are the best tool I've used.”


Recent Posts


Tags

HAS KSS LQDT GEOS OSIS BA EV UN JNJ NEE RMD earnings BG INGR AOS UTX ED BCOR BLL OGE ASNA investment UHS GPC WWW stock research tool LL AA MO DELL CACC EPHC GPS KR SPY BCE BWP AMT technology MNTX CRI CAH POWR EMR WAG ACOM FLO CACI EXC SCL PSX Market Outlook LEN SO DTV ADT THRM ETR MSA PNRA BMRC DD PEG CPB KO ENSG Utilities Sector RSG,RTN food service FAST MRK LLL FTI,HTZ DRI OKS COL WRLD SFG LOW SON 3NSRGY CHE ESI TEVA DTEGY OKE STE stock analysis GME VRTU DMRC BBBY DPS GE BKH PBI PFE UNP HRS Telecommunications WEC ABT MCD INT PPG LKQ ONE long-term growth SJM RKT earnings growth TIF ROST PCLN RDS.A plots earnings INTC JRN PDFS PKG D KMB AZZ JCOM SHW macro ARRS AMCX TSCO COO ED:SCG NVS LXU MTZ POT MCHP HPQ BEAV ITW SWKS LMT PNW AMZN BAP BNS. BAX WFM INWK CVS ITW, SLW APH BHP GWW ACE EMC retirement CAPE SEIC MGRC MSFT AVD CASY DAN short ideas DLR MNR CELG AFSI TGH TEG: WEC: VMI ATW SHOO CTG XOM CPN FBHS T JSFT BLK BH PEP WIN SYK FTR APD consumer FISV HE BR IBN investing for income intrinsic value JCI MKC OXY HP MCY MGEE SYY AXP STMP VZ CLX,EMR market currents MDT PNM ALTE TOT CVX AET CLF MMM SLGN NKE LTM AAPL Valuation diversified machinery EAT NC TWGP AVP M UEPS JWN LH CTL GOLD SILVER due diligence DOV K DVA CSL NSC MIDD EXLS TAC PM RRD ADM MHP ALB AEP ROSE BMS BOFI TNGO FC COP AM stocks V AGLP CKSW NLY DNB DE HNZ SNH HD FDO BOBE FF GIS VVC POR COST QCOM AZO HCI ORCL XEL C SNCR SXL RCII ACM SIG GOOG DTE MHS Macro view SPLS ACN SUBX WLP CB GD FUL TNC RTN GMCR EE WST NOC SAM KMP DFS TMP SU machinery dividends ANDE BDX TWX NFLX value investing TEF CNSL ABC Dividend Ideas TE PPL POM HRL CBRL CSX BAC EK DOW MUR CSCO OHI NSR DGX PG REXX GILD DRC SWK ARLP RSG BRS CL CHS XRX CTRX GT PCP dividends,earnings growth SBUX CLR SCG CHD FRAN TIS BWLD ODFL ADP CTCM APEI TGT TU OII Utilities QCOR CAM SYT MTW VFC RAI EBAY HON CERN TRV PRGO JPM ESRX MNST CBI economy IBM DR KO,CLX,CELG,JCP,GT,MSI,PEP,ED NSRGY ITC BBY PFG HII EMR, MMM WGL UNH P KFT FRED stock research WMT OUTR BCR BEN PRAA ZUMZ BRLI CTSH DGAS COH KMT Stock Research Analysis RRC AFL Fundamentals ULTA WFC IPAR CBU long ideas IR long-term investing IR, RIMM CLX LO FCFS MELI URI CMI ACI DIS PNR TXT FAST Graphs DHR DORM GES FOSL market IDA CAT NOG investing for income,growth and income ECHO AMGN ORI UL JAZZ MATW

Archive

Testimonials

“I appreciate your work, Chuck. As a subscriber to FAST Graphs™, I use the tool to decide on whether to purchase additional shares of what I currently hold or to add a new holding. Your articles help me make full use of the tool and give other readers valuable information, if they take the time to learn. One of the biggest enhancements that I use is the FFO data added for MLPs and REITs.”


“When FAST Graphs™ were unavailable because of Hurricane Sandy, I realized how much I need them in order to make investment decisions.

(Wish I could be) Long FAST Graphs!!!”


“One more vote for the value of FAST Graphs™; just started a subscription to Chuck's great service (premium), and am having a ball analyzing so many stocks quickly.”


“I feel very ill-equipped to make investment decisions without Fast Graphs. :-)”


“Yesterday, I signed up for your F.A.S.T. Graphs™. It's a really amazing, valuable tool for checking over/undervaluation of stocks. Wish I had it years and years ago!!”


“Love the F.A.S.T. Graphs™: One glance and you know a whole lot.”


“About Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


"Chuck -- Your proprietary F.A.S.T. Graphs™ are a VERY impressive tool!"


“If there were an Investor Hall of Fame for people who have helped others with their investing, and sharing valuable information, you and your F.A.S.T. Graphs™ would get one of my selections.”


“I love Chuck's F.A.S.T. Graphs™! Well worth the price of admission for what he gives you.”


"Chuck - Thank you for your well thought out articles. I tend to be a visual type of person so I really appreciate the F.A.S.T. Graphs™ approach."


"Great article, as always! I always look forward to your articles, and am especially eagerly awaiting your next in this series. I find the F.A.S.T. Graphs™ extremely helpful."


“Your F.A.S.T. Graphs™ put all of this in a single artful picture and the accompanying spreadsheets hammer home the point.”


“I use the F.A.S.T. Graphs™ method to evaluate all of my ideas. I recommend it for individual investors, since it helps them focus on data and get past the many emotional arguments.”


“I recently subscribed to the F.A.S.T. Graphs™, and these articles are helping me learn how to better use them. They really do give you a good quick look at the valuations picture. A much needed tool!”


“I also always appreciate the clear-cut information provided through your F.A.S.T. Graphs™ and articles.”


“Thanks, Chuck, for your F.A.S.T. Graphs™. Each of these graphs is worth 1,000 words in describing a company's growth, consistency and valuation. Thanks for sharing your graphs.”


“Thanks, Chuck. Love the F.A.S.T. Graphs™! It makes investing so much more clear.”


“Chuck's F.A.S.T. Graphs™: They are invaluable to me in making decisions about the stocks I own (in addition to what you are saying about doing other research) and the ones I hope to own in the future.”


”I am amazed at the usefulness of your F.A.S.T. Graphs™ and I plan on using them for a long time to come.”


“Chuck's F.A.S.T. Graphs™ will give you a tool to find those well chosen stocks...”


“Thanks for the F.A.S.T. Graphs™, Chuck. They are the best tool I've used.”