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Steve Hamlin
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Valuing the S&P 500 using forward operating earnings "Now, to the issue of P/E ratios based on forward operating earnings. As noted above, it's clear that forward operating earnings are generally much higher than the record level for trailing net earnings to-date, and of course, record earnings are always equal to or higher than raw trailing earnings." "Investors are used to the idea that "normal" P/E ratios are typically in the range of 14 to 16. But as Cliff Asness of AQR has repeatedly stressed, those norms are based on raw trailing earnings. If you calculate P/E ratios based on earnings figures that are higher, you clearly obtain lower P/E ratios." "As it happens, the long-term historical norm for the P/E ratio based on forward operating earnings would be about 12. Of course, that average of 12 includes the heights of the late 1990's bubble. The historical average was just 10.6 prior to that point." Source: http://www.hussmanfunds.com/wmc/wmc070820.htm ------------ "The two main failures of standard FOE analysis are that 1) analysts assume a long-term norm for the P/E ratio that properly applies to trailing net, not forward operating earnings, and; 2) analysts fail to model the variation in prospective earnings growth induced by changes in the level of profit margins, and therefore wildly over- or underestimate long-term cash flows that are relevant to proper valuation. By dealing directly with those two issues, we can obtain useful implications about market valuation." Source: http://www.hussmanfunds.com/wmc/wmc100802.htm John Hussman then goes on to compare popular valuation models to actual S&P returns, and shows and explains why using forward operating earnings estimates with normal P/E ratios is demonstrably incorrect.
Toggle Commented Sep 2, 2010 on Using Forward Earnings at A Dash of Insight
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Sep 1, 2010