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Sources of S&P 500 Total Return
Recent Multiple Decline at Odds with Earnings Forecasts
Broadly speaking, market return can be broken down into three major components: dividend, earnings growth, and change in price-to-earnings ratio (P/E). Dividends and earnings roughly approximate income generated by the underlying firms, while a change in P/E represents shifting market sentiment. It tracks the price move in relation to earnings; a contracting P/E indicates prices are dropping relative to earnings, and vice versa. From a valuation perspective, a lower P/E indicates a cheaper stock market.
In the chart above, we can see that the contraction of forward P/E in YTD 2018 is the largest since 2009. However, the 2009 contraction was roughly matched by the decline in forward earnings projections; that is, the price drop was substantiated by the notion of less future earnings. That isn’t the case today. Thanks in part to tax cuts and a strong economy, forward EPS projections have risen consistently throughout 2018.
In fact, with over 90% of the index reporting Q3 earnings, the S&P 500 is seeing sales growth of 8.32% and earnings growth of 26.77%, one of the best quarters since the 2008 crisis. That said, forward P/E has dropped from 18.3x at the start of 2018 to 16.2x currently, its lowest since 2015.* Should earnings expectations prove accurate, stocks are looking attractive vs. recent history.
*S&P 500 sales and earnings growth and forward P/E data per Bloomberg.
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Past performance is not a guarantee of future results.
Although the information provided to you in this newsletter was obtained or compiled from sources that we believe are reliable, J.J.B. Hilliard, W.L. Lyons, LLC cannot, and does not, guarantee that the information or data is accurate, timely, valid, or complete.
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