(Thanks for Spencer Jakab's market comentary, The Long View, Financial Times 7/31/2010 edition)
We are told that Wall Street analysts expect “earnings [revenue (minus) costs] for 2010 to be nearly 7 per cent higher than they did in January. These bottom-up forecasts call for the companies in the S&P 500 to grow earnings by 33 per cent this year and another 16 per cent next year.”
To put analysts’ forecasts into perspective, consider that in 2008 they were expecting operating earning [= Earnings (minus) interest (minus) tax] for 2009 at $102.78. As it turned out, actual earning almost 50% lower, at $57.20.
Currently, operating earnings stand at $95.79. Growth in revenue, which is tied to growth in GDP, is expected to decline from 6.3% in 2011 from 8.8% in 2010. “US nominal GDP growth averaged 3.25% in the past decade, but companies in the S&P 500 grew their sales by an extra 2.75% on average. Since nearly half their sales go abroad, this was helped by booming emerging markets and big decline in the dollar, which translates to higher reported revenue.
Analysts expect operating earnings to be 9.11% in 2011, which is almost with levels seen at the high of the bubble period of 2005 – 2007. Since 1997, operating earnings have averaged 6.8%.
However, “what if we plugged in revenue growth of 5.75%, forecast nominal GDP growth that S&P 500 have enjoyed over the past decade [= 3.25% + 2.75%], and then applied the average corporate margin [=6,8%]? Earnings would be just $71 a share [in 2011].”
In addition, “plugging in these numbers, the US stocks would be trading at 15.5x [=1,100/71] 2011operating earnings rather than a far more attractive 11.5x [= 1,100/95.79 currently trading]. And since operating earnings are on average about 19% higher than reported net earnings [= (71 – X)/X = 0.19…solve for X, which = $59.66], that would put the market’s actual 2011 P/E multiple at a somewhat pricey 18.5x earnings [=1,100/59.66] using normalized forecasts.”