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Valuations are counting on Earnings Growth
IndexFunds.com Staff
August 18, 2003 |
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Wall Street analysts predict substantial earnings improvement
for US companies in the coming year, and investors have taken
note. The stocks that command the highest Price/Earnings valuations
(the most common measure for how "pricey" a stock is) are those
picked by the pros to most improve their profits. This scenario
will be helped by the fact that firms are bouncing back from a
tough earnings year so comparisons will be easier going forward.
But it will be hurt by an economy that has not shown definitive
signs of takeoff. ETF investors should evaluate the prevailing
optimistic assumption on future earnings, because current stock
valuations appear to be counting on it.
The following chart shows just how bullish analysts are on earnings
growth for major US equities sectors in the coming 12 months starting
August 1, 2003:
Source: IBES
The total US stock market, (represented by Vangard's Total Market
VIPER), is expected to grow earnings a healthy 79%. Only Dow Industrials
ETFs are expected to have flat earnings. And the much maligned
technology and telcom sectors are expected to show the biggest
bounce.
These projections are compiled from financial analysts at brokerage
firms, many of which also pitch investment banking business to
the listed companies. Examples of analyst conflict of interest
such as that of Jack Grubman at Citigroup (formerly Salomon Smith
Barney) have been rampant in recent years, sparking widespread
investor skepticism over the trustworthiness of their projections.
Not helping matters is that expectations of better earnings ahead
appear priced into current stock levels. The following chart shows
a close correlation between P/E ratio and expectation of earnings
growth, such that investors are bidding up prices of stocks where
analysts call for earnings growth:
Source: Merrill Lynch Equity Derivative Strategy
While not the only valuation measure for assessing the market,
P/E ratios are perhaps the most widely used. The inverse of the
P/E, or the earnings yield (E/P), is useful to consider what kind
of implicit return investors would get without earnings growth.
It does not take into account dividends. Nearly all ETFs are showing
earnings yields of single digits, and some are hovering around
risk-free Treasury yield rates. Clearly earnings had better improve,
or investors are likely to flee to safety. The complete data follows:
| Ticker |
Name |
Trailing P/E |
Forecast P/E |
Earnings Yield |
Forecast Earnings Rise |
| FFF |
Fortune 500 |
23.7 |
16.2 |
4.2% |
46% |
| SPY |
S&P 500 SPDR |
27.3 |
16.6 |
3.7% |
64% |
| IWV |
iShare Russell 3000 |
29.8 |
17 |
3.4% |
75% |
| DIA |
Dow Jones Industrials |
16.3 |
16.5 |
6.1% |
-1% |
| IWB |
iShare Russell 1000 |
27.4 |
16.7 |
3.6% |
64% |
| VTI |
Total Stock Market VIPERs |
30.8 |
17.2 |
3.2% |
79% |
| MDY |
S&P MidCap SPDR |
28.9 |
16.5 |
3.5% |
75% |
| IJT |
iShare Small Cap Growth |
23.9 |
17.1 |
4.2% |
40% |
| IJS |
iShare Small Cap Value |
33.3 |
15.2 |
3.0% |
119% |
| IYR |
iShare DJ US Real Estate |
27.4 |
20.2 |
3.6% |
36% |
| QQQ |
Nasdaq 100 |
104.8 |
30.8 |
1.0% |
240% |
| IYZ |
iShare DJ US Telcom |
31.1 |
15.4 |
3.2% |
102% |
Source: Merrill Lynch Equity Derivative Strategy
