Tag: PE Max

96% of S&P 500 component stocks have reported earnings for Q3 2018. Including estimates for stocks that have not yet reported points to a 29% increase over earnings for Q3 in the previous year. What is more interesting is that S&P are projecting a further 2% increase for the next quarter (Q4) and 12% by Q3 2019.

Now these forecasts could be wrong but what they show is that the market expects further increases in earnings in the year ahead. Compare that to the sharp fall in earnings in Q4 2000 and in Q3 2007, before the last two major market down-turns.

Earnings growth may be slowing — it is hard to top a 29% increase —  but why the sharp downgrade?

The perceived level of risk is rising. Primarily because of the threat of a trade war with China, but also problems in the EU with Brexit and Italy. Earnings multiples are being adjusted downwards to compensate for higher risk.

Even after the recent sell-off (orange on the above chart) the earnings multiple for S&P 500 stocks remains elevated. I use maximum 12 month earnings to-date, rather than current earnings, to remove distortions caused by temporary setbacks. The current P/E is still above the peaks prior to the October 1987 and October 1929 crashes.

The difference is that here, earnings are rising. While we cannot rule out further falls, they are unlikely to be as severe as 1987 and our expected worst case scenario is a P/E of 15. While that is harsh, it is a worst case and not the most likely outcome.

If you are a long-term investor, the sell-off should present opportunities to accumulate quality growth stocks. But patience is required. Rather get in too late than too early.