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Every earnings season for the last six years the biggest narrative has been that corporate earnings are going down, so the market must be overvalued. Over the last 15 months, the S&P 500 has returned a whopping 1.2%. If inflation is one percent and taxes eat up 20% of your earnings, you are dead even having invested in the broad based market.
The problem is averages can be misleading. Significant variations occur the group whose earnings or market returns are being averaged. Some do better, and some do worse.
Although it appears earnings have gone down, Barrons’ columnist Ben Levisohn has pointed out that if you exclude the energy sector, earnings of other Fortune 500 companies on average have increased. And as we all know, the energy market has been a big detractor to portfolios (albeit it is up handsomely this year).
Strip out energy losses and you have an S&P that has basically risen 1.2% in the last six quarters--same as S&P stocks collectively, including the energy ones. Bottom line: The market is equally valued the same as it was 18 months ago relative to earnings.
Part of what market prognosticators do to make their predictions is to poll analysts to looking for a consensus view on future earnings growth. Some outliers predict 10% earnings growth, but that’s definitely a minority opinion. It’s not one that we at Beacon share; we like most others are expecting much smaller growth.
At the same time, earnings aren’t the only driver of stock prices. Also important are interest rates and cash being returned to shareholders. Companies are returning on average 20% more of cash flow generated than they did 15 years ago. The result is that between dividends and stock buybacks the corporations are returning 4.7%, which exceeds average yields the yield on a long-term corporate bonds (4.2%).
Looked at through that broader lens, stocks do not look overvalued to us.