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The following discussion reviews corporate operating earnings trends derived from other sources. Aggregate S&P 500 operating earnings are a critical input for both our Real Earnings Yield Model and our Reversion-to-Value Model.
We update this discussion every few weeks as new data becomes available.
Over the long term, corporate earnings are a principal driver of stock valuations. Two sources that publicly track aggregate operating earnings for S&P 500 companies are:
With the recent merger of Thomson Corporation and Reuters Group PLC, Reuters has discontinued public issuance of weekly aggregate S&P 500 earnings updates. Thomson Reuters does track aggregate corporate earnings/forecasts, but the company does not make summaries publicly available.
Since the methods used by these companies for aggregating and summarizing earnings data differ, their outputs are not identical.
We use Standard and Poor’s publicly available earnings data in both our Real Earnings Yield Model and our Reversion-to-Value Model because of the robustness of data they make available.
See our blog entry of 8/29/06 for a comparison of the usefulness of operating earnings versus cash flows, and actuals versus estimates, as stock valuation drivers. See also our blog entry of 1/12/07 for discussion of the relationships among aggregate earnings, inflation rate and stock returns.
The following chart shows actual and estimated year-over-year changes in aggregate bottoms-up operating earnings by quarter for the S&P 500 companies during 2007-2009 from Standard and Poor’s.
See our blog entry of 4/3/07 for results of research on the implications of earnings acceleration (change in earnings growth rate) for future earnings and stock returns.
What is the longer-term behavior of these data, and how stable is the forecast?
The next chart depicts the actual year-over-year changes in aggregate operating earnings by quarter for the S&P 500 companies since 1990 from Standard and Poor’s. It shows that operating earnings varies widely across periods of economic expansion and recession. The average nominal change for the entire sample is 7.8%. The average inflation rate is about 2.9%. See our blog entry of 12/28/07 for another perspective on long-run trends in S&P 500 operating earnings. See also our blog entry of 1/12/06 for a summary of an influential paper on long-run mean reversion in corporate profitability.
To test the stability of earnings growth estimates, the next chart presents the the evolving estimates from Standard and Poor's for year-over-year changes in operating earnings by quarter for the last three quarters of 2008 and all of 2009. Forecasts continue to fall at most horizons. The earnings growth rate estimates for far-future quarters have sometimes risen because estimates fell faster for current and near-future quarters. Estimates can change substantially over periods of weeks.
As noted below and in our blog entry of 2/20/07, earnings forecasts normally tend to shift from optimistic to pessimistic as release of actuals draws near.
Note that the conservatism engendered by the Sarbanes-Oxley Act for management and by Regulation FD (Fair Disclosure) and the Global Analyst Research Settlements for both management (guidance) and analysts (estimates) may have skewed earnings estimates downward in comparison with the past. For research that addresses potential biases in earnings estimates, see our blog entries of:
7//22/08, for perspectives on the valuation implications and sustainability of earnings growth.
7//11/08, for examples of how S&P 500 aggregate quarterly operating earnings forecasts evolve from initiation through earnings season.
5/20/08, for a study of the impacts of Regulation FD and the Global Analyst Research Settlements on sell-side analyst earnings forecasts.
2/21/08, for a comprehensive and organized overview of past research on equity analyst inputs, processing and outputs.
4/9/07, on the conservatism bias of investors with respect to both downside and upside extremes.
2/20/07, on the tendency of earnings forecasts to shift from optimistic to pessimistic across reporting periods as release of actuals draws near;
1/15/07, regarding the effects of the 2002 Sarbanes-Oxley Act (SOX) on management-analyst earnings dynamics;
11/16/05, for evidence that Regulation FD has leveled the playing field for analysts at large and small firms;
9/16/05, regarding the earnings estimate biases of analysts who work for brokers;
8/8/05, summarizing patterns and informativeness of management earnings guidance;
7/26/05, on the tendency of analysts to underreact to good company news when revising their earnings forecasts; and,
7/12/05, regarding the effect of Regulation FD in making analyst earnings forecasts less accurate (with some follow-up commentary in our blog entry of 7/17/05).
