The reality of S&P 500 earnings

To say that stocks are anything other than dangerously overpriced with a P/E of over 130 and a yield of 2.5% on unsustainable dividends is either farcical or fraudulent.


For such a simple little metric, the P/E ratio is subjected to all kinds of perversions to deflate it to levels that can be passed off as reflecting value. At the very least, most bubbleheads try to make it less scary than its current level of 133 for the S&P 500.

Do-it-yourself P/E and dividend analysis

It is very easy to find out what the real index PE is at any given time. Just google S&P 500 earnings, and right at the top you will see a link to an Excel file on S&P’s website. Download it and see the data for yourself. The file provides 20 years of history on operating earnings, “as reported” (net) earnings, and cash dividends for the benchmark big-cap index.  Here is a permalink to the latest Excel file.

When talking P/E ratios, look at “as reported earnings,” which are the real bottom line, or as close as today’s accounting methods get to it. “Operating earnings” are all the rage these days with the sell-side and CNBC crowd, since they of course are higher, as they don’t include pesky items like depreciation, taxes and interest. Even more ridiculous is the use of “forward operating earnings,” which are not an accounting entry at all, but just what Wall Street analysts are telling the public that companies might report in future quarters and fiscal years.

To get the real P/E, the one that has been used as a gauge of value for decades, take the sum of the last four quarters of “as reported earnings”. Through Q1 09, for which 99% of companies have now reported, the index has earned a 12-month total of $6.87 (with the index at 915, the P/E is 133).

An S&P analyst has noted in the file that if Q3 comes in as expected, trailing 12-month earnings will be negative for the first time in history (I bet CNBC will decide to ignore that little factoid, since it’ll be a hard one to spin). Earnings are down from an all-time 12-month peak of $84.95 as of Q2 2007. To be fair to the bulls, the current figures include a loss of $23 in Q4 2008, when financial companies took their write-downs, though surely more of the same are on the way, and not just for banks.

Today’s earnings vs. recent history

Q1 2009 earnings were about $7.53, and Q2 and Q3 are expected (analysts tend not to be that far off for quarters directly ahead) to be more or less the same, so we are on pace for about $30 in annualized earnings. A glace at the historical data shows that this is about the same level as in 2001-2003, after a peak of $48-54 for a few quarters in 1999 and 2000. You have to go back to 1994-1995 to again see the $30 level, with the $20 level about the norm from 1988-1993. Assuming that the $30 is sustained, you could say that the current P/E is 30. That’s not value in anyone’s book.

Dividends from la-la land

One particularly striking fact in this data is that 12-month dividends have hardly budged from record levels, coming in at $27.25 as of Q1 2009. Dividends had been growing fairly moderately and steadily from 1988 to 2005, increasing from the $9 to $20 level over 17 years. At the height of the credit binge, companies were flush with cash to give away and buy back stock at inflated prices, rather than pay down the debt they took on to generate those temporary earnings. That they are continuing to pay these high dividends says to me that managers are in total denial or are playing charades to maintain the illusion of health.

The index only yields about 2.5% on current dividends, but if dividends fall back to just 2004 levels, the yield would fall under 2% if the index still trades at 900. Keep in mind that secular bear markets bottom by enticing with high cash yields, as investors by then are too pessimistic to expect much in the way of capital gains. At the 1930s and 1970s bottoms, the market yielded over 10% and 7%, respectively. Just a 5% yield on 2005-level earnings ($20) would be the 400 level on the index. A 7% yield on 1998 yields would mean the index trades under 250.

Whether you are a deflationist or inflationist, you have to admit that a strong dose of either would not be kind to equity valuations. In the ’70s, people demanded high current yields because future yields were so heavily discounted by inflation, and in the ’30s, stock valuations became extremely depressed as earnings tanked and investors panicked.

A crude indication of solid stock values is when the S&P 500 yields over 5% and the P/E is under 10. Stocks can get cheaper than that, but at those levels you really can buy for the long run. To say that stocks are anything other than dangerously overpriced with a P/E of over 130 and a yield of 2.5% on unsustainable dividends is either farcical or fraudulent.


For reference, here is a link to S&P500 earnings and dividend data going back to 1960.

Glancing at the typical ratio of earnings to dividends, if the index is earning $30, one should expect dividends to be about $10-20. There is no record here of another time when dividends were higher than earnings, as they are at present. This says to me that the sustainable yield today is not even 2.5%, but more like 1% to 1.5%, comparable to the peak of the peak dot-com bubble.

From this level of overvaluation in the face of declining fundamentals, stocks could fall hard for another 18 months to restore value fast (1929-1932 model), in which case the 200 level is likely by 2011.  Another outcome is to trade in a range for a decade or more and wait and hope for a bout of moderate inflation to increase the nominal bottom line (1968-1982 model). A third possibility is the Japanese model, where the S&P would get to 200, but over 20+ years. Long-time readers know that as a deflationist and Elliott waver I expect the first outcome, with the most stunning phase of the bear market soon to come.

Getting close: Japan may have just made a bottom.

The Nikkei sold off 9.38% last night, closing at 9,203. Coming after a long and steady decline (from 18,250 in June ’07), such a dramatic move to deeply oversold conditions reflects capitulation — the market just throws in the towel. Afterward, who is left to convert to a bear? Bullish sentiment readings in Tokyo must have dipped well into the single digits.

5-day view here:

Source: Yahoo! Finance. Click image for larger view.

Now, I am not calling a final bottom in Japan, since yields are still low and this global depression has a lot further to run, but this may be a major stage bottom. Rallies from such intermediate lows can be extremely powerful, as the fear of losses subsides and gives way to the fear of missing out on gains.

The world markets have been moving together through this bear market, so a capitulation in one major index suggests that relief may be near for the rest, although they may have to make their own dramatic plunges first. Here is a 2-year view of the Nikkei (blue), Europe (VEURX, green) and the S&P 500 (red). Note that the chart does not reflect last night’s dive in the Nikkei.

Source: Yahoo! Finance. Click image for larger view.

Now, once this bottom is in, the rally should only be of interest to traders, not long-term investors, because once it peters out we are going plunge all over again. Anyone who needs these funds for retirement or their kids’ tuition or who is not a proven trader should get out and stay out. Don’t even look at the market news for the next two years, because you will be tempted to jump back in at just the wrong time.

Can’t make your retirement plans work without 8% compounded returns? Well, better scale down on those plans and increase your savings, because this bear is here to stay. The whole concept of putting the bulk of your life savings in the stock market is one of the biggest scams of all. Stocks are a horrible way to save. They are good for investing when they are cheap, and good for speculating if you are a pro, but as a savings instrument they are terrible. What kind of a savings instrument routinely loses 50-90% of its value?

The pervasiveness of the belief that one should save in stocks is a product of a bull market. People had different opinions in the ’30s, ’40s and ’70s. Before long, newspaper columnists will again promote Treasury bonds for saving, and at that point you might want to look the other way and consider that stocks could be cheap.

I would like to be a stock bull again — it is more fun. But I am going to wait until things are really cheap and paying nice dividends. Even after 30% and 50% plunges, respectively, US and Japanese stocks are still only yielding about 2%. Furthermore, dividends are being slashed left and right, so the expected yield is even lower. I want to see at least 8% yields before I buy stocks and put them away.

In 1932, the yield on the Dow briefly hit 15%. That speaks as much to the strength of American industry at the time as it does to the depth of the crash. I would be surprised if US companies hold up as well this time.

P/E’s are Nil on Dow and Russell 2000

Click image for sharper view. Source: Wall Street Journal Online

Earnings have gone negative. How’s that for value? Remember, most bear markets end with P/Es below 12, sometimes 7. Even the value play in the group, the S&P 500, will have to fall by more than half to get there, without any further contraction in earnings.

And what kind of fools see value in equity yields under 3%, when earnings have grown above trend for years? Stocks are all risk with no reward. You can get these yields on 1-5 year treasuries right now.