What’s the Right Time Horizon to View SP 500 Earnings ?

In a nutshell, I’d say about 12 – 15 months forward and the data can be sparse beyond 12 months.

Much was learned from the Q4 ’18 correction, which will be discussed in a minute, but for now let’s cover the SP 500 earnings data from this weekend:

SP 500 Earnings (by the numbers): as of Friday, February 7th, 2020’s This Week in Earnings, IBES by Refinitiv:

Forward data:

  • Fwd 4-qtr est:  $175.98 vs last week’s $176.76
  • PE ratio: 18.3x
  • PEG ratio: 4.31x
  • SP 500 earnings yield: 5.45% vs last week’s 5.48%
  • SP 500 y/y growth rate: 4.26% vs last week’s 4.46%

Remember, the last bullet point is the “forward 4-quarter” estimate divided by the same estimate 52-weeks prior, so what is being measured is the “rate of change” of the forward estimate. This has not been clear and has been confusing to readers. This format will be changed in coming weeks to make it easier to read and understand. Because the “rate of change” is being measured this distorts the PEG ratio, which I’ve found isnt very useful as a metric anyway, but we’ll address that later.

The “rate of change” declined this week for the first time since late December ’19 a metric we’ve been tracking here and posting here for readers.

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It’s highly probable that the coronovirus worries and the declining earnings estimates in Energy, Basic Materials and Industrials / Transports have finally hit home in the rate of change for forward earnings.

Let’s see if it lasts.

The PEG ratio above is calculated by dividing the 18.3x PE ratio by the forward rate of change of 4.26% = 4.3x

Backward data: 

  • TTM actual: $164.30 vs last week’s $164.38
  • PE ratio: 19.6x
  • PEG ratio: 2.6x
  • SP 500 earnings yield: 5.09% vs last week’s 5.07%
  • Y/y growth of TTM est:  7.11% vs last week’s 7.94%

The “TTM actual” is the trailing twelve-month actual earnings with the latest quarter being the current quarter being reported or today’s case the 4th quarter of 2019.

The “y-y growth” is the forward estimate divided by the TTM estimate which in this case leaves us with a 7.11% growth rate, fading from the 10% expected in calendar 2020 using the IBES data.

What’s the right time horizon to view SP 500 earnings ? 

After the 4th quarter, 2018, correction i went back and looked at the “forward 4-quarter” estimate data to see if there was something I missed. The following spreadsheet data was cut-and-pasted from that time period:

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Note the period from mid-September through early October ’18.

The SP 500 peaked at 2,940 the week of September 21, 2018.

Note the week the “fwd 4-qtr est” growth rate peaked – yes, the week of September 21, 2018.

Now here is where the ambiguity comes in: using calendar estimates from IBES by Refinitiv, the expectation for 2019 SP 500 earnings growth was for 10% already, so some slowing in the rate of growth was expected, simply from lapping the tax reform stimulus.

What wasn’t expected and wasn’t know until early April, 2019 was that the SP 500 EPS growth rate for 2019 would slow from an expected 10% – 11% to 0% – 1% eventually.

The SP 500 was telling us this by correcting 20% in 12 weeks time, as the SP 500 estimates tried to catch up.

So what’s the point (as Jeff Miller would pointedly ask me) ?

The rate of change in SP 500 earnings is an important clue to the direction of the SP 500.

That rate of change peaked the week of September 21, 2018 with the SP 500 at 2,940 heading into the Q4 ’18 correction, and the rate of change bottomed on November 1, 2019 at a just barely positive metric. The SP 500 started its powerful Q4 ’19 rally on October 15th or thereabouts so there is some correlation, but be wary of the timing.

It’s another arrow in the quiver but hardly a perfect timing tool (yet).

Summary / conclusion: Like a lot of metrics around earnings and trading and economics, some are useful and some are not. This blog is going to redo the above SP 500 earnings data in the next few weeks and months to give readers better data but don’t rely on this exclusively. The “rate of change” is an important metric for SP 500 earnings, but there is no reason it can’t fall from 22% as it did in September ’18 to 10% and then bottom and start higher, with the market looking through and not reacting much to the metric change.

The recent bottoming in the rate of change on November 1 ’19 (see the first spreadsheet above) has gradually advanced until this past week. Does that mean we are looking at another 20% correction ? Hardly.

Don’t overlook too the simplicity of the calendar year earnings growth either. The “forward estimate” which is modeled for our individual equity holdings and valuation spreadsheets gives that “intermediate PE” for stocks where investors are looking at either a 3-month PE or a 15-month PE.

Look for the above SP 500 earnings data to be repackaged and shown differently. The presentation has to be improved for readers.

Thanks for reading.

 

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