The talking heads on TV financial news programs and elsewhere in the media are pounding the table saying that the stock market is trading at a price/earnings (P/E) of 10. So therefore, this is a screaming buy!
To which I say —— which E ?
They’re naturally referring to fantasy E. Fantasy E is what you get when you:
- guess at what next year’s earnings will be using an assumption that revenue continues to grow, profit margins grow, and therefore earnings grow.
- ignore this year’s earnings and those of the past few years.
- ignore any bad stuff that happens.
In other words it is pure speculation, and based on nothing going wrong.
Over the past 11 years, the S&P500 has seen the following as-reported earnings. As reported earnings are real earnings reported to the IRS. This is as opposed to what Wall St prefers to use: Earnings from operations. Earnings from operations allow CFOs to skillfully ignore bad stuff that happened.
Here’s the data….
Over the past 5 years, the S&P500 averaged $59 in as-reported earnings. (I’ll round up and be charitable.). Think the economy for the next year is going to be appreciably better than the past 5 ? (if yes, you clearly have not been reading these articles.)
It’s a safe bet next year is going to deliver -at best- $59 of as-reported earnings. Let’s make the math easy and call it $60. The S&P500 index is slightly over 1200 as I write this. That makes for a P/E of slightly over 20. That’s not a screaming buy. It is 25% higher than the long term Shiller P/E average of 16. It is also twice the P/E you hear from the talking heads in the financial press.
The only way you may claim stocks are cheap right now is of you are delusional, not very bright, or a combination thereof.
Which E you use in calculating P/E depends on whether you use empirical data or fantasy data. Apparently, it also depends on whether you are in the business of selling mutual funds that are solely based on holding stocks no matter what.