As of late-May, we’ve seen 99.4% of the companies in the S&P500 index report their 1Q 2009 earnings. The results are:

  • Earnings are about 24% lower than analyst estimates. (analysts continue to over-estimate earnings and thus stock prices)
  • Earnings are 44% lower than 1Q 2008
  • The gap between operating earnings (earnings before bad stuff) vs real earnings (aka as-reported earnings) is canyon-like. This shows that CFOs are hard at work trying to spin their dismal earnings results into something that might attract an ill-informed investor. (think lipstick on a pig).
  • As-reported earnings are projected to be negative for the 12 month period ending Sept 31st 2009. This will be the first time in the history of the index this occurs.
  • As-reported earnings for the quarter will be approx $7.60, and about $27 for the 2009 year. With the S&P500 trading around 930, that translates to a P/E of 34!!! This is more than twice the long term average of 15.
  • For those becoming skeptical that we may not see the US stock markets return to P/Es close to 15 – the as-reported P/E on the S&P500 was 17 for 1Q 2007. That’s not 15, but it sure isn’t 34.

Earnings are what define the price of stocks – more than any other attribute (except fear & greed). Stock prices are a reflection of what is referred to as the result of a series of discounted future cash flows. More simply: add up the anticipated earnings for a given company in the next few years and allow for the time value of money to reduce the impact of those projected future earnings.

As our readers know well, if we divide the current stock price by the estimated earnings, we are left with a representation of how high or low the current price of the stock is – relative to its estimated earnings – the P/E ratio. Clearly, the higher the P/E ratio, the higher the price we are paying for that estimated stream of future earnings. The long-term average P/E ratio on the S&P500 index is 15.

Sustained, long bull markets in the USA have NEVER begun when P/E ratios are appreciably above 15. Example: the great bull market of 2003-2007 began with a P/E of 23 on the S&P500 index. The index almost doubled in value in 4 years, then gave it all up to see 12-year lows. Earnings and P/E values are important. They tell us when we’re paying too much and when markets are over-priced. You may have to be willing to wait a few quarters or even years for markets to be reasonably priced, but buying equities when they are over-priced is a recipe to lose money. Long term wealth is created as much by not losing money as it is by making money.