Monday, August 1, 2011

S&P 500 Earnings & Valuation

Why is the stock market holding up so well? Corporate revenues and profits continue to fly despite the weakness in US economic growth. That’s because companies are finding lots of both around the world. While nominal GDP was up only 3.7% y/y during Q2, the revenues of the 337 S&P 500 companies that have reported their Q2 results are up 13.1%. They are up 16.0% excluding the Financials (and Bank of America's big hit during the quarter).

Industry analysts seem to be tuning out the bears. There’s no sign of any stalling in bottom-up earnings forecasts. The S&P 500 consensus estimate for 2012 actually rose during the last week of July to a new high of $113.78 per share, up 15.0% from the latest estimate for 2011, which edged up last week and continues to hover around $100. As a result, S&P 500 forward earnings, which is a time-weighted average of the current and coming years’ earnings estimates, also rose to a new record high last week of $107.50.

Let’s say that the economy doesn’t stall during the second half of the year and that forward earnings converges with the 2012 estimate at $115 by the end of the year. That would put the S&P 500 at 1380 if the forward P/E remains at last week’s 12.0. If the P/E rises to 13.0, the S&P 500 would finish the year at 1495, very close to my “1500 for the 500” target. Of course, if the soft patch is turning into a mud pit rather than a hard patch, as suggested by the latest GDP and ISM reports, then earnings would tank and so would the P/E. That’s not my forecast, but it certainly is a credible risk given the latest data.

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