Research Articles

Strong Standard and Poor's 500 Earnings plus Weak Stock Values equals Opportunity

Julie C - Friday, September 09, 2011

S&P 500 Earnings are Strong + Stock Values are Weak = Opportunity

Extensive research, experience and analysis spanning more than 40 years has taught me that earnings determine market price in the long run.  I have dubbed this principle with the acronym EDMP.  However, there also exists a short-run evil twin sister EDMP.  This principle states that emotions determine market price in the short run.  Currently, the evil twin sister EDMP is in charge.  In the longer run, I believe this spells opportunity based on the oldest of all investing adages "buy low sell high."

 

Earnings Are Strong

Dirk Van Dijk, a Director of Research at Zacks Investment Research, recently published an article titled: Earnings Strong, Economy Not.  The following excerpts tell the S&P 500 earnings story:

“The Earnings Picture

Second quarter earnings season is effectively over, with 497 or 99.4% of the S&P 500 reports in. With the exception of a handful of financials, most notably Bank of America (NYSE:BAC), which had a $12 billion negative swing in net income from last year, this is another great earnings season.

The year over year growth rate for the S&P 500 is 11.9%, way off the 17.1% pace those same 497 firms posted in the first quarter. However, it you exclude the Financial sector, growth is 19.4%, actually up slightly from the 19.1% pace of the first quarter. At the beginning of earnings season, growth of 9.7% was expected, 12.2% ex-Financials.

Attention will now start to shift to the expected growth in the third quarter. Things are expected to slow a bit, with 12.30% growth expected overall, and 11.9% if the financials are excluded. While that is down fairly significantly from the second quarter, especially ex-financials, it is right in line with what the expectations for the second quarter were before companies started to report.

Top-line results were also very strong, with 10.45% year over year growth for the 497, actually up from the 8.77% growth they posted in the first quarter. The top-line results are even more impressive if the Financials are excluded, rising to 10.71% from the 9.49% pace of the first quarter.

Top-line surprises have been almost as good as than the bottom-line surprises, with a median surprise of 1.76% and a 2.46 surprise ratio. The revenue growth in the first half is remarkable, given only 0.4% GDP growth in the first quarter and just 1.0% in the second, with low overall inflation. High commodity prices helped revenues among the Energy and Materials sectors, and higher growth abroad and currency translation effects from a weak dollar have also helped.

Looking ahead to the third quarter, year-over-year growth of 6.16% is expected for the full S&P 500, and 6.38% growth if Financials are excluded. At the very start of reporting season, revenue growth of 9.62% total growth was expected, and 8.94% excluding the Financials.”

Stock Prices are Weak

The following F.A.S.T. Graphs™ covers the earnings and price relationship of the S&P 500 since calendar year 1992.  All of the earnings numbers come directly from Standard & Poor's Corp.  (Note that only every other year’s data is typed on the graph due to space constraints, however, each year’s data points are plotted on the graph).  The orange line represents earnings multiplied by the S&P 500's 150-year historical normal PE ratio of 15.  The blue line represents the S&P 500's last 20 year’s normal PE ratio of 20.  The black line represents monthly closing stock prices.  The green shaded area graphs earnings, and the light blue shaded area shows dividends paid out of earnings.

There's an important lesson on statistical analysis that I believe this graph offers.  Although it is statistically correct that the normal PE ratio for the S&P 500 over the last 20 years has been 20, the graph shows that this number is somewhat misleading.  In truth, there have only been a few times over the last 20 years where the S&P 500 was valued precisely at 20 times earnings.  Clearly, as the graph vividly illustrates, stock values have often been dramatically above 20 times earnings, and often dramatically below 20 times earnings over this time frame.

Consequently, I offer that this graph provides a much more relevant and comprehensive view of the S&P 500's relative valuation over the last 20 years than the statistic does.  Of course, the same can be said of the 150-year historically normal PE ratio of 15.  On the other hand, it's interesting to note from the graphic below that this is the only time in the last 20 years that the S&P 500 has been valued significantly below the normal 15 PE ratio.  To me this indicates that the S&P 500 is currently on sale. 

The following graph plots the S&P 500's price to sales ratio since calendar year 1992.  The current price to sales is low relative to historical standards.  Once again, to me this indicates attractive current valuation. 

Conclusions

If the S&P 500 achieves the earnings goal of $98.57 as estimated by the above graphs, its year-end 2011 earnings justified fair value would be 1478.45, which is approximately 23% higher than it currently sits.  To be clear, this is a mathematical calculation based on the current and near-term earnings power of the S&P 500 companies. Also, based on current earnings estimates, the earnings yield for the S&P 500 is 8.4%, which is approximately 4 times higher than the yield on the 10-year T-note.  Therefore, this is not a forecast that it will get there, only a calculation indicating that it should.  The following excerpt from Dirk Van Dijk’s article cited above corroborates this view: 

"In an environment where the 10 year T-note is yielding 1.99%, a PE of 14.5 x based on 2010 and 12.5 x based on 2011 earnings looks attractive.  The PE based on 2012 earnings is 11.3 x.  Those PEs are based on the Thursday close (9/02/2011), some are even lower after Friday's fall (and the likely decline on Tuesday given the weakness in Europe on Monday)."

With all the negative talk that we are consistently fed, the truth is, that corporate America is strong.  The fundamentals underpinning most of our great companies warrant higher valuations than they are currently receiving.  With interest rates at all-time lows, and therefore, the price of bonds at all-time highs, they are less competitive to stocks than normal.  Consequently, I believe that equity valuations should be higher than normal, not lower.  Therefore, I feel that now is a great time for investors to be building equity portfolios whether the market is at the total bottom or not.

Disclaimer: 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.

 


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

JOY ESI DMRC market CBI MSFT SIVB FDO fundamental stock research tool CAT SCHW dividends beta SHPG HCI HOG short ideas FinancialSector AMT SHOO ITW, KALU ITW Materials biotechnology ATW BOKF BAX TOT ACI NPM ACM EnergySector FUL Aristocrat BOBE LTM TIS SHW AFL FOMC MCD RJF FairlyValued intrinsicvalue OHI,EPR,WPG,JLL TNC PRAA long-term growth X act SAM BIIB blue-chip ACQ TSCO POR SBUX CASY DELL ZUMZ investing UNH ACN TGI Dividend Champions GLT BCR Share Buybacks DIS MAT CanadianBanks SPY TE EXLS HP CRI GPI DRI HBI BCOR SWFT Challengers CSCO V PKG WST O FRAN DE JAZZ TMP BRS AB KFT FLO BMS VMI BPL WLP CVX,SWK,MCD,TGT,PG,WMT,JNJ,MDT,AFT,T,ED interest rates ONE highqualityR BG M CCK K NA SJM GPS BWP AIRM Bond,TGT,UTX LOW THFF PB stock analysis IPAR ODFL ECL CATY MSA DOV APEI BHP PRXL FAST Graphs MO US Economy value-oriented LLL value MDT fair valuation HCP RSO SAVE TEG: WEC: FF VVC WGL DHR NSRGY BOFI NVS CPN UNP DTV dividends,earnings growth Fundamentals KMT TUP GNTX WEC CINF 3NSRGY CSX BANF CTG HCBK HCN VCO C EBAY WY WVR WFM BLK AMBN VAL P POT ED PPG Overvalued WASH PortfolioDesign AZO TGH cashflow DOM MYL GAS value trap CTCM PII CMI DRIP Consumer discretionary MRK Telecommunications dividend growth investing AVD dividendGrowth LEN RSG HNZ MDP UL DORM RKT SUBX ABC RBC market timing EE investing for total return InformationTech intrinsic value,stocks,earnings,fundamentals,stock research tool,due diligence INGR MPW HRL dividend COO ANTM HD BBBY AGLP total return value investing STE CGY DGX AFSI ADP CAPE SNI EK REITs RRC Utilities Sector NLY MCK LO WRLD VRX VZ cash flow KO InterestRates R long-term investing AAP URI RRD ROSE investing for income biotech ITC SLW HGT GWW cyclical ARRS Utilities SCL BH WAG machinery PAG COST STMP CHS ALTE NFLX mid-cap ORI SCG EAT NOC CRLI ABT ESRX AGN WIN BA RDS.A SU MHP XRX NKE marketvaluation AEP HIBB SYNA UN UTHR CTAS BNS BNS. CKSW MAN AMCX banks FAF CTRX HCA SoundValuation SYT TICC QCOM RS dividend growth stock AKRX Buffett DDS THRM economy DKS WMT,ROST,GIS,GE,JNJ,KO FLIC earnings ZBRA SO ABBV PCL CPB EV TAC NC MCHP diversified machinery FB ConsumerDiscretionary Industrial WU SYK BIDU PEP BEN dividend income ETN growth stocks ETP AM CNC SNH MATW AET SFG T BRLI MUR IDA BAP BCE AMAG DRC MGRC PCLN JRN BHB HighQuality DFS GrowthOriented AOS PRGO FTI,HTZ CLX,EMR AMP EWBC CHE MIDD NROM intrinsic value fastgraphs FTR PEG NEE AXP CSL dividend paying stocks GILD ENDP TIF stock research tool Yield DTE SWKS SHR MAIN healthcare LH AFG GOOG HSY HSNI VRTU Dividend Ideas blue chip regional banks hyper growth stocks AEG PNM POM HE TNGO BR DECK AFAM earnings growth Contenders LKQ DividendIncome high-yield market currents AMZN RAI utility stocks OZRK ARLP Macro view GOLD fast-growing LINE BBY stocks MHS portfolio CLX DTEGY Champions RY XOM TGT BF.B LMT ABM GPCM sell CTBI TU PNR DNB PBI OII THO AAPL GMCR CR WMT NSC DollarCostAverging COP ANDE MELI stockResearchTool ICLR MKC CB INWK CBRL FOSL ECHO FISV SILVER PPL AMG CVX AFL,CVX,ED,JNJ,MCD,PG,SWK,T,WMT,TGT,ABM,AFL,BEN,BMS,CB,CBSH,CTBI CM CFR GD ACOM KO,CLX,CELG,JCP,GT,MSI,PEP,ED DividendChampions FCFS true worth THC F investing for income,growth and income GE GPC HRS MNK DividendAristocrats MA ORCL RMD WHR LL dividend paying BLL FairValuation D GIS INTC REXX TROW best-of-breed due diligence RTN CTL XEL AVP CELG MTW INFY OKE PDFS WWW PNRA GME dividend-growth LXU retirement PFG RSG,RTN FRED OGE BigFive,Canadian EPHC FL IR, UHS free cash flow ALB UNM PCP DGAS PSX Valuation COH ACE PG JKHY MNST ASNA OHI CVS KMP ADM ETR stock research EXC FBHS Market Outlook MNTX DLPH LZB MSCC CBU OUTR PM Aristocrats CXRX IR NOG BEAV BAC HAS CAH TSM HPQ Stock Research Analysis WFC MMM EMR, MMM PFE ATHM DLR JPM capital appreciation GES SEIC VFC MTZ APD KR BDX JCI JSFT SON COL long-term TWX RCII BMO CACI ACR AMGN CHD AAN growth WBA INT SNCR DAN dividendpaying GOOGL CL macro long ULTA TEVA TWGP MCY CERN JWML.Y long ideas AA EMC HII POWR BWLD CLF TXT MNR SIG LLY KMB SRCE NSR GT food service fair value CLR UTX KCAP QCOR JWN SWK AZZ treasury OKS SBRA AIG CNSL GEOS MGA ENSG TEF OXY long-term returns HON JCOM mid-sized CACC CTSH HSC BMRC JNJ IBN APH KSS DVA LQDT BKH FC WSM DPS SLGN OSIS RIMM FDX DD NTES FAST suvivorship basis DOW SXL IBM DR PNW dividend-paying UEPS SPLS EMR CIO investment CE SYY ROST MGEE CAM SBR technology VTR ED:SCG TRV consumer BMTC ADT suvivorship

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.”