S&P 500 Earnings Estimates -- Is the Market Calling Their Bluff?

A major argument for the bullish case is that forward P/E estimates for the S&P 500 are very attractive.  From Standard & Poor's website, you can download the historical and estimated quarterly EPS and P/E ratios for the S&P 500 at this link.  As shown in the chart below, the estimated P/E ratio based on bottoms up operating EPS is expected to decline throughout 2008 (the yellow line represents the estimates for all 4 quarters of 2008).  The P/E ratio for the fourth quarter of 2008 is currently estimated to be all the way down at 13.49.  Based on these estimates, the market looks very attractive.  As shown, while the index is still very close to all-time highs, its P/E ratio is well below where it stood in the late 90s at similar market levels.

But are these estimates actually going to play out?  The P/E estimates above are based on estimated operating earnings.  Below we provide historical and estimated operating earnings as provided on S&P's website.  As shown, earnings for the next four quarters are currently expected to be inline or higher than they were when the economy was roaring in late 2006 and early 2007.  While the economy might end up not being as bad as everyone expects, we certainly don't expect it to be as strong as it was in recent years.  These earnings forecasts for 2008 seem a little too high to us, and based on its performance recently, the market seems to think they're too high as well.   

Comments

[Turley Muller]

Terrific article!

I completely agree with your analysis. I don't see any other logical conclusion that can be drawn. I had commented about the same anomaly on my blog. I invite you to take a read.

http://financial-alchemist.blogspot.com/2008/02/do-low-multiples-mean-market-is.html

[Brian Dulger]

Can you explain what "bottoms up" and "top down" means in the estimates context?

Many Thanks!

[Walt French]

Brian, S&P takes the consensus of all analysts who cover a stock, and adds up the 500 such consessa (?) to build the "bottoms up" view. Meanwhile there are some analysts who take a stab at the 500-stock total, based on macro-economic or other such views -- "top down."

There's often a goodly difference. The top down guys can take an educated guess based on the most recent signals while the bottoms up analysts are maybe better at differentiating the buzz between competing firms in the same industry, and typically can't pick up the sensitivity to recent news about consumer confidence, etc.

[Jerry Stewart]

Dear sir, Why are you suddenly defining P/E - as PRICE to OPERATING EARNINGS? P/E is defined as PRICE to EPS - no OPERATING EARNINGS (which are earnings before all the bad things)

If you stick to the regular defined P/E - and use an estimated NET PROFIT EARNINGS of (say) $54.82 for the S&P 500 - then at current price of $940 - the P/E would calculate at 17.15.
That is HIGH for a recessionary period. If you use a P/E of (say)
12 - then the S&P500 could be $658.
You are WAY too optimistic. Jerry Stewart

[Matt]

When I go to S&P link you list it shows me "operating earnings per share" and "as reported operating earnings per share". This may be a dumb question - but what is the difference between these? e.g. what does an "as reported" EPS mean for 12/31/08 which has not occured?