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Majority of Investors Worry About Divergence Between Corporate Earnings & Market Levels

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According to FactSet, as of the market close on August 25, over 98% of companies in the S&P 500 have reported earnings for the second calendar quarter earnings season. Of those, 71% have reported positive earnings surprises–actual earnings were above the mean estimate.

For the second quarter, the blended earnings decline–reported earnings decline as well as forecasted earnings decline for those companies that have not yet reported–is -3.2%. The second quarter is the first time the S&P 500 index has recorded five consecutive quarters of year-over-year earnings declines since the period Q3 2008 through Q3 2009.

As of June 30, the forecasted earnings decline for the S&P 500 companies for the third quarter was -5.5%. During the latest earnings season, 77 S&P 500 companies issued negative EPS guidance–lowered their EPS forecasts–and 33 companies issued positive EPS guidance.

As companies report their latest quarterly earnings and issue updated guidance, analysts update their earnings models and adjust their earnings estimates for companies. So last week we posed this question to our readers:

How much of an impact does the trend in consensus earnings estimates or upward and downward earnings revisions have on your decision to buy or sell a stock?

Here are the results:

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In all, 1,160 responded to this poll questions. Of those who responded, 88% say they invest in individual stocks. Of those that do invest in individual stocks, two-thirds said that they do pay attention to the trend in earnings estimates or earnings revisions when making buy and sell decisions. However, the overwhelming majority of those said there was only a light impact (79%).

Weekly Special Question

FactSet also reported that the forward price-earnings (P/E) ratio for the S&P 500 as of the close on August 25 is 16.9. As this chart shows, the puts the valuation of the S&P 500 near a 10-year high.

2016-08-28_6-04-28

With the S&P 500 on pace to record six consecutive quarters of year-over-year earnings declines and the index near a 10-year high in terms of its P/E ratio, we asked out readers the question:

Are you worried by the divergence between corporate earnings growth and the new highs in the stock market?

In all, 192 readers said whether or not this divergence between corporate earnings growth and the stock market’s valuation worried them. The majority of respondents–60% in all–said that, to some extent, they are worried by this divergence. Out of this group, 10% said they are only slightly worried.

Here is a sampling of the responses:

  • “Absolutely!!! Ultimately earnings drive stock prices. Future cash flows from earnings will determine the price of stock. If earnings go down, then eventually the price of stocks will go down.”
  • “I do not worry about much of anything regarding the markets. The highs in the stock markets are mainly due to the artificially low interest rates. There is no alternative to US stocks in my opinion. Earnings growth will again be an important factor when the rates are more normalized, which may not happen in my remaining lifetime.”
  • “I’d generally hesitate to buy a stock if the stock’s price was surging way out of proportion to the growth in earnings. People who buy such stocks probably believe that the company has some new product or service for which there will be an exceptionally high demand. I have little faith in forecasts. I think a company’s performance over a long period of years is a fairly good indicator of likely future performance.”
  • “No, but I expect that a market correction isn’t too far down the road.”
  • “No. As an investor with a long view, I don’t worry about much of anything. There will be a correction, and when it comes I will enjoy having my dividends reinvest at the lower prices. Most of my dividends do not reinvest automatically, so I can use them to buy more shares in the companies I want to grab when the correction comes.”
  • “Yes, particularly since earnings for too many corporations are a result of cost cutting to the nadir and not necessarily increased revenues.”

And the honors for “best” answer of the week goes to:

  • “You mean things don’t make sense? Look who’s running for President. Now that’s something to worry about.”

Want to weigh in? Participate in our weekly member poll, updated every Tuesday, and see the results online at http://www.aaii.com/memberquestion.

 

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