Friday, July 24, 2009

Update to Market Valuation and PE Q2 '09

As everyone seems to be interested in what I have to say about the PE of the market from viewings of these past entries, here is an update on what I see over the past few days of quarterly earnings while it is still on everyone's mind.

With 53% of S&P 500 companies reporting, Q2 '09 earnings are close to estimates of $10.56 per share. What does this mean for PE? Well, taken at face value (meaning we don't adjust out the $23.25 loss in Q4 '08), earnings for the prior 12 months will be $4.56 per share. At a current level of $976, this gives the S&P a PE of 214.

If Q3 earnings don't hit $8.47 it will be the first 12 month period in history where US companies will have lost money in total. PE will be incalculable. When you divide a positive number (the amount of money a person pays for a share of earnings) by a negative earnings number, the result is negative. PE will not measure how many dollars investors will pay for one dollar of corporate earnings, but for a dollar of loss. This reality should knock the wind out of you.

Looking past face value, if we adjust out Q4 '08 and replace it with the Q1 '09 earnings number of $7.52, that gives us TTM (trailing 12 months) earnings of $35.33 per share resulting in a PE of 27. This valuation is about 3 times higher than the low value in any bear market, excluding 1987.

What was the lowest PE we hit in the bear market we just finished? The S&P hit bottom at 676 on March 9, 2009. With TTM earnings of $14.48, the PE was 46, adjusting out Q3 '08, gives us a PE of 15.

Where from here? On the high side, assume final earnings for Q2 '09 could hit $10.70 (right now on path to hit $10.56). Say over the next 12 months we get earnings of $44 per share ($11 per quarter). At $976 the forward PE would be 22.

As I have been reading through The Fourth Turning, I wonder if Baby Boomer habits will permanently change to thrift and savings. If their savings becomes investment in public capital markets (and foreign investment doesn't pull out the rug), maybe a downside PE of 15 is realistic. That puts the right number on the S&P 500 at $660. That sets the middle, but does not account for the boundaries, which I have widened on both sides given some interesting occurrences in corporate earnings, and even more interesting developments in government.

More importantly other markets exist where the numbers (PE included) don't require manipulation to even calculate them.