Which S&P P/E Ratio Are We Talking About?

By: Richard_Shaw

Business news about earnings and P/E ratios is frustrating and flawed.  If you listen to and read enough reports, you find wide variances in the numbers.  Why?

It's all about the “E”.  Nobody has trouble figuring out the “P”, but the “E” has many possible meanings:

• Reported earnings
• Earnings before “items”
• S&P Core earnings
• Earnings on a trailing 4 quarter basis
• Current earnings (typically 2 quarters back and 2 forward)
• This calendar year earnings
• Next calendar year earnings
• This fiscal year earnings
• Next fiscal year earnings

This week, we have seen S&P 500 reported as having a P/E of 12 and 13.5 in the press.  Barron's Market Lab said 24.22 as of last Friday.  We've also read 20 and 24.

The problem is that reports are seldom delivered with an explanation of the basis of the “E”.

So here is a report with the explanation.

Standard & Poor's on their site provides earnings history and short-term estimates.  We think “as reported” earnings are the most meaningful (we think earnings before items is silly, because there are always “items”). 

Here are the “as reported” earnings from S&P for various time periods, along with the corresponding P/E.  We can all agree that the closing “P” today was 1207 for the index.

• E trailing 4 quarters = $52.67 (P/E 21.3)
• E trailing 2 quarters + estimated 2 forward quarters = $59.57 (P/E = 20.3)
• E estimated forward 4 quarters = $60.32 (P/E = 20.0)
• E estimated calendar 2009 4 quarters = $58.87  (P/E = 20.5)

An ETF tracking the S&P 500 is SPY.  Morningstar reports the forward P/E as 13.5.  They certainly aren't using “as reported earnings”.

The rule of thumb used by the Fed under Greenspan was that an S&P P/E equal to 100 divided by the 10-year Treasury rate was OK.  With those Treasuries at 3.83% today, a P/E of 26 would be OK.  We don't know if that rule ever made sense, but it doesn't make sense in the current circumstances where Treasuries are massively purchased in a run for safety from the equities meltdown.

We think US large-cap stocks are expensive from both a P/E perspective and a technical perspective ( see our recent article ), which leads us to believe that a test of $105 (from the current $121) for SPY is possible to likely — and that if $105 is breached, look out below.

We could be dead wrong, of course, but feel there is more fundamental bad news ahead, that the unknown unknowns are more in number and greater in significance than normal, and that the willingness and readiness of investors to rush back in (as they did with a pre-market S&P increase of over 6% the morning after the idea of a total bailout was announced) is a sign that capitulation has not yet occurred. 

When what is perceived as good news does not light fires of greed, then we are at the bottom.  We aren't there yet.

Richard Shaw

By Richard Shaw 
http://www.qvmgroup.com

Richard Shaw leads the QVM team as President of QVM Group. Richard has extensive investment industry experience including serving on the board of directors of two large investment management companies, including Aberdeen Asset Management (listed London Stock Exchange) and as a charter investor and director of Lending Tree ( download short professional profile ). He provides portfolio design and management services to individual and corporate clients. He also edits the QVM investment blog. His writings are generally republished by SeekingAlpha and Reuters and are linked to sites such as Kiplinger and Yahoo Finance and other sites. He is a 1970 graduate of Dartmouth College.

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