Wednesday, November 9, 2011

Earnings Expectations Remain High

Expectations in investing--as in life--are crucial to satisfactory outcomes.  In investing, high expectations for company performance--earnings growth particularly--tend to lead to disappointment.  Conversely, low expectations tend to lead to positive surprises--and profits.  This is why value investing has superior results over time, as cheap stocks tend not to be as bad as the consensus thinks and expensive stocks reflect the outstanding growth prospects that are obvious to even casual market observers.

Forward earnings growth expectations for the stock market overall are an important indicator of market expectations.  Over the past 32 years, when consensus earnings expectations for the next twelve months for S & P 500 are at least +14.2%, the S & P has had negative returns (excluding dividends).  When earnings growth expectations are moderate (earnings growth of 4%-14.2%), returns have been 7% annualized.  When expectations are low, however (less than 4% growth), the annualized return on the S & P 500 has been 17%.

At the end of October, the consensus earnings growth forecast for the next twelve months was 14.1%.  This is down from a high of more than 21% earnings growth that was forecast early in 2010 (before the big decline in stock prices).  Even further declines in growth forecasts to more realistic levels would help support stock prices.
Steve Lehman

S & P 500:  1276

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