Along with today's revision to second quarter GDP, we received the first estimate of corporate profits for the quarter. Profits rose 3% from the first quarter, and are up 25% in the past year. Plus, they continue to look very strong relative to GDP.
The worst thing you could say about corporate profits, as Art Laffer argues, is that corporations may be doing their best to accelerate profits—to book profits now before taxes go up next year. So profits might be overstated to some extent. But I see profits growing consistently for several quarters, so I'm not sure how significant the overstatement is. Regardless, it remains the case that profits have more than doubled since 1998, while the S&P 500 has not budged, on balance, over the past 12 years. As I've been arguing for a long time, the equity market looks very undervalued to me. Perhaps that's because, like the bond market (see my post from yesterday), the equity market believes the future will be very grim.
Note in this last chart how the NIPA measure of profits continues to be a leading indicator of accounting profits (which are used to calculate standard PE ratios). With strong profits growth likely to continue, it's hard to believe the equity market is going to remain at depressed levels for much longer.
S&P 500 ttm Operating Earnings per share is
ReplyDelete73.33 (2nd qtr 2010)....NIPA
corporate profits after tax is 1197...73.33 divided by 1197 is 6.13%...the 30 year historical median is
7.4%...meaning for S&P 500 operating earnings to match the historical median to NIPA corporate
profits it has room to run to 88....
Scott, your post is echoed by revenue results in the State of Oregon. Corporate tax:
ReplyDeletehttp://www.ktvz.com/news/24771582/detail.html
"the latest load of bad budget news for Oregon state government held a shiny nugget for businesses - the prospect of a $40 million "kicker" tax rebate.
Companies slashed payrolls and overhead through the recession and are holding back spending in the anemic recovery. As a result, many are making good profits.
That's showing up in Oregon state revenue. Corporate tax collections are ahead of projections made last year."
The Obama team inherited a economic train wreck into a financial sewage treatment plant.
ReplyDeleteNow corporate profits are setting records.
Really, we just can't stand any more of these D-Party presidents.
Scott,
ReplyDeleteThanks for your great analysis. The second chart looks a little scarey. It appears that profts have peaked just before market corrections. Am I seeing this wrong. Please explain.
Thank
"accounting profits (which are used to calculate standard PE ratios)"
ReplyDeleteThis is simply incorrect. Your so-called accounting profits are operating earnings and they always overstate true earnings. It does not include extraordinary items like the hundreds of billions of dollars banks wrote down during the crisis, along with many other real costs that are funnily categorized as xo items. Operating earnings is just a scam Wall Street created to fool investors. The trailing 12M operating earnings of the S&P is $75. The true earnings including everything is only $61. With S&P trading at 1065, its P/E is 17.5. Long term historical average, I believe, is around 14, Let's say 14.5. So the market is 20% overvalued. Its fair value is 850.
So, given that profits are up, why are not seeing dividends increase?
ReplyDeletePragmatic,,, 12 month trailing
ReplyDeleteearnings for GAAP ( all the stuff you talk about) is 67.20 as of the end of 2nd qtr 2010....1065 divided
by 67.20 = 15.84....Average from 3/27/1926 to 7/25/2008 was 16.0
from 1/21/1980 to 7/25/2008 was 19.4.....S&P GAAP earnings yield is
as of today 6.31%....Moody's Baa yield ( medium grade bonds) is 5.55%
In December 1994...the S&P 500 was
ReplyDelete459.27.....the 12 month trailing GAAP earnings was 30.60...for a 15
p/e....Moody's Baa yield was 9.1%
then....
brodero,
ReplyDeleteWhat is your data source for the Q2 earnings? It's impossible to have it since not all companies have reported yet.
490 of the 500 companies have reported...
ReplyDeleteCheck out this web site
http://www.standardandpoors.com/home/en/us/
You have to register but it is free.. I believe they update weekly...
I searched all over the place on that website and still couldn't find what you are referring too. All I found is the $61 EPS as the latest available number.
ReplyDeleteLet's assume your numbers are correct. Besides the facts that P/E should be adjusted for cyclicality to predict long term stock returns and 12M trailing P/Es have never been a good indicator(S&P's P/E was 20 at the 2007 peak and 120 at the March 2009 bottom), my main points remain valid:
1. It's incorrect to say operating earnings are accounting earnings for P/E calculation. The author here either is not honest or lacks basic understanding.
2. The market is not "very undervalued" as the author claims compared to long term historical average.
Just trying to give you data...you don't like 12 month trailing reported earnings..you don't like operating earnings...you don't trust NIPA profits....enjoy your 7 year treasury at 2.09 %
ReplyDeleteThanks. Enjoy the bear market. I don't have a problem with your data. I've made my main points crystal clear in my last post.
ReplyDeleteNo matter what numbers you use and how you massage them, valuation is a subjective exercise. My prefered measure of profits is in the national income and product accounts (NIPA). They purport to be true economic profits and they are based on corporate filings with the IRS. By that measure stocks are very undervalued.
ReplyDeleteWjmk: I assume dividends are not up for the same reason that corporations are reluctant to reinvest their profits. There is way to much uncertainty about taxes and regulations among other things.
ReplyDeleteScott, what do you think about the coments of Hussman's regarding NIPA profits? Here is the link http://hussmanfunds.com/wmc/wmc100719.htm
ReplyDelete"They purport to be true economic
ReplyDeleteprofits"
Do they really? If a bank loses billions of dollars on its loans, does it not have an economic impact on the company? Does it not hurt its shareholders? I am afraid that using reported earnings is not massaging numbers. Using NIPA earnings is.
Scott,
ReplyDeleteWith all the talk about a bond bubble and expectations of future inflation, is it therefore too risky to have any exposure to bonds in one's retirement portfolio? I've heard many advisers say that you should have the same percentage of bonds in your portfolio as your age (I'm 48). That seems dangerous given your observations.
America's public companies need to get back to paying attractive dividends to their shareholders. Of course, large public corporations abhor parting with their hard earned profits favoring instead aggressive reinvestment of earnings. However, the times we are living in may require that investors be treated to some of those earnings. Increasing dividends may also improve investor morale and mitigate investor fears in this "uncertain" economy. Increasing dividends would send a positive signal separate from profit reports.
ReplyDeleteGrannis is correct that NIPA profits are more telling about the inter-temporal economy than S&P500 profits.
ReplyDeleteYou could look at a snapshot of the differences here.
After all, there were only 619 additions (and hence deletions) to the S&P500 between 1976 and 2005.
But, I guess Grannis has never heard of multiple expansion and compression when it comes to stock prices and stock profits. In the long run (1871-2010), the current multiple is somewhat above the average.
Shiller does a nice job with his CAPE which explains why the total real return of the S&P500 is flat for the last decade, and the next 10 years are dicey based on historical precedent.
Dividend increases?
ReplyDeleteIf it looks likely that dividend taxation goes above 20% next year then look for special dividends on 12-31-2010 for many corporations. After that much less incentive to raise divs in the greater then 20% scenario.
Buddy, there is no need for special cash dividends. Corporate managers are screaming to high heaven that Obama raises taxes on dividends. Well they are actually silent for public consumption and media purposes.
ReplyDeleteThe reason is simple. Corporate cash allocated to stock buybacks are way better for managers' stock option compensation than cash dividends, ceteris paribus. Keep it a secret, though: you wouldn't want Jane to throw her Chardonnay on you when she found out.
All you need to do is ask Howard Silverblatt at Standard&Poors for some uptodate info on the dividend-buyback ratio.
Here is some outofdate info with this Legg Mason Buy-Back Mountain chart which clearly shows the rise of management compensation via stock options through 2006.
And now you why economists occupy such few seats in the corporate boardrooms of the nation.
J&J: There is no perfect measure of profits, but I've been using the NIPA measure for a long time, following the advice of Art Laffer. I have compared NIPA profits to trailing earnings in many posts here, and the differences do not appear to be as large as Huffman asserts. In fact, NIPA profits tend to lead earnings, and they are less volatile to boot. Laffer used NIPA profits to successfully issue a strong sell signal for stocks in late 1999. Since then, NIPA profits have been signaling an undervalued stock market, so the buy signal has not been impressive. Keeping all this in mind, however, I continue to believe that looking at NIPA profits can be of help, as long as you remember that nothing is perfect.
ReplyDeleteBill: Treasury bonds are a lot more risky here than corporate bonds. If T-bond yields rise, corporate yields are likely to rise by less, resulting in a narrowing of credit spreads. This would be perfectly normal assuming that rising Treasury yields occur as evidence of stronger GDP growth emerges. The best value in the corporate sector is BAA bonds and BB (high yield), where yields are still reasonably attractive.
ReplyDeleteScott,
ReplyDeleteAs always, thank you for your insight. I wish economics were more science than art, but then trying to predict human behavior is certainly no easy task. I guess I have to keep telling myself that this country has faced very difficult times over the past 100 years or so and managed to come through it somehow despite some pretty serious errors in monetary and fiscal policy. Let's hope we can do it again.
Marmico is spot on re-dividends. Profits do not make their way back to shareholders so there is an increasing disconnect between assumed value and realized value.
ReplyDeleteYou can fool some people some of the time but you cannot fool all the people all of the time.
The stock market is no longer a vehicle to connect producers with sources of capital. It is merely a tool for the transfer of wealth from one group to another.