FTFY
thanks bchad. especially true in sideways markets like we are in since 2000s
http://awealthofcommonsense.com/what-drives-stock-market-returns/
It’s true that coming down from a PE of 40 can take a looooong time, though the first steps are the big ones.
the 3rd chart is very interesting…anyways no one has a magic ball, is 100 years of data sginficant?
I just updated my model, this is something I’ve been building in my free time; global equity valuations/forecast. Here’s the most solid base case I can generate for the US. Remember, the definition of a base case, is the most probable case. Realistically this usually means a continuation of current state EXCEPT when the current trend cannot continue. We NEVER include fantasy growth rates and price bubbles in a serious base case, that is reserved for high case.
BASE CASE 2016-2025:
* Nominal GDP continues at 3.3%, the 10-yr avg
* Inflation (CPI) continues at 2.0%, the 10-yr avg
* EPS growth rate continues at 3.2%, the 10-yr avg
* Dividends continue at 2.3%, the 10-yr avg
* Current P/E is NOT able to hold at 23.0X, fed rates go up but not too high, mult comes down to 20.5X, the 20-yr avg
* Add a year 1 EPS recovery equal to 1/2 of the -14% EPS loss, so +7% growth yr1, 3.3% for the next 9yrs.
TOTAL RETURN = 3.4% earnings growth + 2.3% dividends -1.1% multiple contraction = 4.6%.
INDEX 2089 today, 2612 by 2025 YE, EPS $127, P/E 20.6
^ Yeah, I’m pretty happy with that, not bullish or bearish, just a very likely outcome. Any serious forecast has to show earnings. Upcase I say unlikely 5% EPS growth (the 20 year avg), or more likely a bubble up to 25X+. Downcase I say my previous, multiples contract hard, years of digging out of the hole with a nasty earnings recession (which is just starting now).
The earnings peak of $105.96 in 2014 Q3 was unsustainable though. There were years of earnings based on a bubble in commodity prices, those earnings are gone, and may never return. These guys need to start building their EPS back up, I don’t see why we should assume some fantasy recovery.
Those people are idiots though, which is how I keep beating the market. They probably believed Yellen when she said low oil was a “net positive”, I called bs on that from the start, and I call bs on all the fantasy forward-looking earnings and GDP growth rates.
That seems fantasy though. EPS growth is correlated with nominal GDP growth (though way more volailte). There is no recent precedent for EPS that far above GDP (for 10yr periods). The 25yr avg is 4.5% GDP and 5.9% EPS, but both the GDP and EPS’s spread above GDP has been steadily coming down. Yes, the 5yr avg EPS growth is 4.8%, but that’s only because there hasn’t been a recession yet. There will be, in fact this might be the start.
I am not saying you are wrong, but what is your equivalent calculation for China, India, or some other emerging economy?
Ok, that’s a sensible logic, PA, and seems well thought out. The largest disagreement is on the rate of earnings growth. The data I carry around in the back of my head is that over the long term, earnings have grown at around 6%, with some noise, and this seems to be during high interest rate regimes and low ones. This analysis comes from John Hussman’s work. I haven’t looked at the data myself recently, so perhaps I would change my mind if I revisited it. Still, the 6% figure is remarkably durable over the long term – however, a business cycle is approximately 8-10 years so a decade’s worth of earnings growth might not match up exactly to this 6% figure.
Remember that although revenues tend to be tied to GDP, earnings get affected by all sorts of things like competitive advantage, operating leverage, financial leverage, tax treatment ands subsidies, and the whole Porter 5-forces stuff. The bigger thing that might support your case is whether profit margins can be maintained this long, which is driven in good part by the weakness of labor vs capital in claiming any gains from productivity improvements. Is that weakness temporary or permanent is hard to say, but if jobs are being outsourced and automated and income is being concentrated, there are reasons to suspect it could be (largely) permanent until underconsumption effects kick in. If profit margins can’t be maintained, then there is a stronger case for slower EPS growth than a simple “GDP is slow” kind of argument, particularly if a company is a global one.
Multiples do seem high, and are likely to contract over the next decade, but stranger things have happened. Yes, the 10y treasury rate is awfully low, but we had 40x earnings in 1999 when rates were at least twice as high as they are now and closer to the post-war long-term average, so there is precedent for rates to be 250 bps higher and PE ratios actually expanding. Sure 40x was not sustainable, but waht about 25x? or even just staying put at 20x? I agree that they seem likely to contract, but it’s far from assured.
Also, your 4.6% figure does fall into the 4-12% error range, and given that your analysis presumably has a range as well, one can ask if these analyses come to statistically significant different results. This is why my comments are saying that the original scenario is plausible but the error bars are enormous, so there’s not much to ooh and ahhh about.
My point was not that 3500 is a good estimate to bet on; merely that it isn’t all that implausible, and given that we can’t predict any of the inputs to much precision, it’s not that surprising or even impossible to get to 3500. It’s not as silly as the Dow 360000 stuff we saw a decade and a half ago.
earnings yield is 5.1%. dividend rate is about 2%. so annual reinvested capital is 3.1%. add 2% inflation and you get the 5.1%. using this 3.1% as your real EPS growth figure assumes that the ROIC on this 3.1% is zero. as real GDP growth is most likely to be positive over the next 10 years, especially outside of the U.S., i’d expect the average ROIC to be well above zero. this is why i stated that 5.1% should be our absolute lowest expectation for EPS growth. i have confidence that in aggregate, CEOs of S&P 500 companies will invest their capital in a way that generates a return above zero. the only way i could be wrong on this minimum 5.1% assumption is if the U.S. capital stock is so badly depleted that boatloads of sustaining capital is required to simply maintain earnings. this is very unlikely as U.S. capacity utilization remains well below average.
using gdp growth to forecast EPS growth probably isn’t best as S&P 500 companies capture far more than just U.S. GDP and often times U.S. GDP is captured more so by small businesses or private companies. i’m sure bchad can talk on this far more than i can. looking at the situation from a bottom-up perspective, like i have, at least sets a floor for EPS growth.
earnings have been impacted by one-time write-offs, not only earnings contraction. by taking unadjusted S&P 500 EPS as scripture, you’re assuming that these write-offs will occur every year. so even if you’re right that oil will stay at $40 forever, you’re wrong in your assumption that earnings will not naturally rebound solely for the fact that the writeoffs stop. FCX’s $4B writedown alone accounted for a 0.5% decline in the TTM S&P 500 earnings. APA’s $6B writedown accounted for a 0.75% decline in S&P 500 earnings. is FCX going to writeoff $4B in assets every year? is APA going to writedown $6B in assets every year?
CHK accounted for another 0.75% in EPS decilne. Southwestnern another 0.5%. i can go on all day.
$107 EPS is the correct figure. deal with it.
I like that we have gone full nerd , nerding out is my specialty. 
Yeah, the revenue input is where I always differ. Been doing this a long time: 1) I build a killer model, 2) front-office dude says “yo PA, let’s put this fantasy revenue number in there!”, 3) I’m not a dick and give them what they want for the external model with some “fuzzy logic” talking points to justify it, 4) for our own internal I win the fight to keep it a reasonable number, 5) time moves forward and nobody makes as much money as they thought, 6) investors get burned using our hype number. Ah, the lovely finance biz! Exactly. The GDP to EPS relationship is the hard part which I’m still building (top secret). That might need to become a multi-factor model with margins and all that. Right now it’s just using historic, super primitive.
Maybe you know more about this than I do. I’m taking a very high-level approach, but religiously sticking to using S&P’s as reported $earnings per share change over time. The model forces everything in the end to be explained as EPS x MULT = INDEX. Index EPS grew thru ups and down from $66.47 in Q3 2005 to $90.85 in Q3 2015, 3.2% CAGR. That’s nominal of course, I don’t bother with inflation (assume it stays the same). It’s what they have available to pay out or retain, so I don’t bother with dividends (assume they stay the same). Maybe that’s dumb and I’m missing something, or maybe it’s because I’m not modeling based on “earnings yield” ($90.85/2090)…in my model index value is an output at the very end. EPS (ttm) CAGR (coming down with nominal GDP): 25yr 5.9% 20yr 4.9% 10yr 3.2% Wouldn’t foreign income already be included in EPS growth? There are smart companies like AAPL and their China sales are in there. Thus foreign profits are already figured into GDP growth as exports right??
Do you work front-office by chance? It feels like you just pulled that number out of nowhere. That’s 18% higher than the Q3ttm as reported EPS. I would never start with that as the base value upon which future growth happens.
Same magic forumula at the core. Higher nominal GDP and decent profitability translates into higher EPS growth, and starting from a position of low multiples (and a path for multiple expansion like SOE reform and opening of capital accounts), we should expect as base case higher index values for say CN, vs countries that are backed into a corner like US/JP. IN has high GDP growth, but if they have low profitability, and are starting from a high multiple, then they don’t do as well in my model. Of course various risks like currency, political, etc get layered on top…it’s possible to nuke yourself thru stupidity, like BZ. The hard part is data, I need a job with a Bloomberg terminal, and even then it might be hard to get country data that is comparable and trustworthy.
I wrote an essay over here on the topic, seemed like it fit better into the other thread…
http://www.analystforum.com/forums/investments/91345269?page=1#comment-91652397
^ i gave you 4 specific examples of write-offs that account for $2.50 of the S&P earnings decline that come directly from energy sector WRITE-OFFs. nearly all other energy companies have writeoffs as well. you’re free to look them up. basic materials companies have been writing off like crazy as well.
your $90 TTM number is WRONG. it may be less than $107, as some adjustments besides energy company write-offs are necessary, but it is most definitely not the $90 figure that you are positing. it could be more than $107.
you can’t simply ignore write-offs.
Bottom line, meaning real accounting, earnings are f@#$ed.
As of the new Excel that just came out, it’s now EPS (ttm) $90.90 (almost all Q3 earnings have been reported now). Writeoffs happen, they are real, they hit net income, that’s life. If next quarter earnings are $95, then that’s what they will be, or maybe oil will go lower and there will be more writeoffs.
The sad thing is that aggregate earnings growth over the last 5 years has only been 2.5%. There have been $2.3T in buybacks which have propped up the EPS number. Without the buybacks it’s more like $83 EPS, 25X P/E.
The bull market is totally made up guys, it’s almost entirely multiple expansion and buybacks, both of which were fueld by QE/ZIRP, which are now ending. So projecting forward…not a good 10-yr outlook.
Why would you ignore non-cash charges when using P/E as your valuation methodology? There’s a good chance that poor performing assets being written off actually enhance EPS (in the coming quarters) rather than continue to dilute EPS even as adjusted EPS growth rates continue to decline.
who said were in a bull market? been sideways since 2000s
The proper calculation of trailing P/E = index price as of last trading day close / most recent ttm earnings.
There’s a lot of truth to that. Nailing that down a bit using P to E…
Prices rose faster than EPS in 2000, S&P=1500, hitting 29X valuations, the whole thing crashed. By 2007 the S&P was still only 1500, EPS had caught up somewhat and valuations were 19X, BUT the earnings were high-risk unsustainable finance earnings, so the whole thing crashed again. By 2012 the index was 1500 yet again, and EPS had recovered to 2007 levels, this was fairly valued. But moving forward to 2015 EPS did not budge (even with massive buyback manipuation), yet the index surged up (another dotcom-like bubble). If the index comes down to fair valuation, we’re right back to 2000 index of 1500!
Things ARE moving forward in that earnings ARE growing, but not very fast. And that should be no surprise, since nominal GDP growth, and thus earnings growth, is low. You can’t grow a $18T economy very fast. The friction comes from investor expected returns of 8% , when only 5% max is sustainable.
Yes, that is the finance 101 equation for trailing P/E. Now to the question, why aren’t you adjusting for write-offs? Lack of realiable data or something?
^ no it’s because he obviously hasn’t picked up a CFA textbook before. what CFAs are trained to do, more than any other designation, is to adjust/normalize earnings. he clearly hasn’t grasped that normalizing earnings is the key function of a CFA charterholder.
To be fair to PA he is still building the model out and comparing to historical averages is easier if using nominal earnings figures vs. having to adjust everything. Do reliable data source offer like-for-like view(s) of adjusted EPS?
Non-recurring items do have a real effect on assets and income. To the extent that they have some kind of normal average and spread, it isn’t terrible to include them in a PE estimate, although you do have to ensure that you are comparing apples to apples and not compare them with estimates that filter that stuff out.
While the non-recurring items are probably pretty lumpy on a company by company basis (which is why you pretty much always want to adjust company earnings). I’d imagine that they probably do have some bell-shaped distribution when you total them up over an index like the S&P 500. I’ll bet there’s some study about that already. I’m surprised that I haven’t already looked at that data myself over my career and so don’t have the result in the back of my mind already, but I’ve been working on other stuff I guess.