Here is our January 6th, 2014 EPS scenario, and here is our first crack at 2014 earnings from back in mid-November ’13.
To simplify the math and the reading comprehension, we plan on updating the 2014 EPS estimate every 6 weeks or so, around the middle of each quarter and then around the first week of the quarter:
Current top-down 2014 EPS estimate: $117.58
Current bottoms-up 2014 EPS estimate: $119.40
Average of the 2014 estimates: $118.50
Current 2013 top-down estimate: $108.99
Current 2013 bottoms-up estimate: $109.44
Average of the 2013 estimates: $109.25
$118.50 / $109.25 = 8.5% expected EPS growth in 2014.
Since such a large component of the SP 500’s return is “p/e expansion” and the SP 500 (per our Weekly Earnings Update) has been averaging a PEG ration of 2(x) – 2.5(x), then a conservative estimate of the p.e ratio assuming 8.5% earnings growth in 2014, would be a PEG of 2(x) or 17(x) that earnings growth.
2013 ending value for SP 500: 1,848.36
$109.50 * 1.085 = $118.80, times a 17(x) multiple = 2,019.73 estimated ending value for the SP 500 on 12/31/14.
2,019.73 / 1,848.36 = 9% expected market return using the more conservative estimates (i.e. average earnings, modest p.e ratio). We think this might be a tad conservative.
If we used a $110 ending estimate for 2013, and expected 10% earnings growth for 2014, that would result in an ending EPS of $121 and assuming a 2(x) PEG of the 10% growth, or a 20(x) ending ’14 p.e. the ending value for the SP 500 on 12/31/14 could be 2,420 or what would be a 30.9% return for the SP 500 (2,420 / 1,848.36). We think that this estimate is too aggressive.
Small changes in earnings estimates, earnings growth rates and multiple’s, can result in large changes in return forecasts. Look at the difference in an 8.5% earnings growth rate and 17(x) multiple versus a 10% earnings growth rate and a 20(x) multiple.
Our best guess is still that we could see a 20% year for the SP 500. That is a BIG “could”, though. Byron Wein was out on CNBC yesterday saying the same thing. Not sure how he got there in terms of the math.
Although it seems like a meaningless metric, on April 1, I will be anxiously watching what Thomson Reuters sets as the “final” SP 500 EPS number for 2013, i.e. $108.99, $109.50 or even $110. That 2013 final EPS estimate matters – that will be the base we will set for the next 2014 EPS update slated for April 1, 2014.
Thanks for reading. It seems involved, but it is really simple math.
Trinity Asset Management, Inc:
Brian Gilmartin, CFA