Declining profit estimates for the S&P 500
Profits for the S&P 500 companies, according to Thompson Reuters, declined by 3.5 per cent in the December 2015 Quarter relative to the December 2014 Quarter. The 30 per cent decline in the oil price over those two periods, from US$53/ bbl to US$37/bbl, lead to a 75 per cent collapse in energy companies’ profitability.
In the March 2016 quarter, profits for the S&P 500 companies are expected to decline by 5.7 per cent year on year. “Earnings management” by corporates has seen this figure come down from an increase of 2.3 per cent three months ago. While some reduction is common – whereby companies can “beat” the most recent consensus forecasts – the 8 per cent reduction is not.
The pro forma profit numbers compiled by Thompson Reuters are different to those under generally accepted accounting principles (GAAP) as they treat management bonuses and recruitment costs, as “one off expenses”. The same is true for regulatory, litigation and merger/acquisition expenses. We note these “extraordinary expenses” seem to recur with monotonous regularity.
For 2015, the Thompson Reuters profit number for the S&P 500 companies was nearly 30 per cent above the GAAP number. So when market commentators claim the S&P 500 is selling on a PE of 17.5 times (1,938 index points / earnings of $110.74 per share), please remember this is being somewhat kind.
Profit for the S&P 500 companies using generally accepted accounting principles is $90.57 per share, pushing the market up to a PE of 21.4 times, 30 per cent above the 60 year average of 16.4 times. With profit expectations being downgraded, the US market looks far from compelling value, and all Montgomery funds continue to hold a solid weighting toward cash.
To learn more about our funds, please click here, or contact me, David Buckland, on 02 8046 5000 or at dbuckland@montinvest.com.
Chief Executive Officer of Montgomery Investment Management, David Buckland has over 30 years of industry experience. David is a deeply knowledgeable and highly experienced financial services executive. Prior to joining Montgomery in 2012, David was CEO and Executive Director of Hunter Hall for 11 years, as well as a Director at JP Morgan in Sydney and London for eight years.
This post was contributed by a representative of Montgomery Investment Management Pty Limited (AFSL No. 354564). The principal purpose of this post is to provide factual information and not provide financial product advice. Additionally, the information provided is not intended to provide any recommendation or opinion about any financial product. Any commentary and statements of opinion however may contain general advice only that is prepared without taking into account your personal objectives, financial circumstances or needs. Because of this, before acting on any of the information provided, you should always consider its appropriateness in light of your personal objectives, financial circumstances and needs and should consider seeking independent advice from a financial advisor if necessary before making any decisions. This post specifically excludes personal advice.
Luke Joseph
:
David do you have a view on Priceline or Expedia? Very surprised that you don’t seem to hold them in the fund. Cheers.
paul kloeden
:
Is the 60 year average PE of 16.4 based on GAAP earnings or the Thompson Reuters numbers?
David Buckland
:
Hi Paul,
The 60 year average PE of 16.4X used GAAP, however the difference between this and the Thomson Reuters pro forma profit numbers were very small up until a few years ago.
Guy Davis
:
Not to mention record high profit margins being embedded in those PEs. Price/Revenue would probably be even more concerning. Thanks for the article David, it is nice to know that like minded (and much more knowledgeable) investors share similar concerns on valuation. I have been moving more and more defensive over the last 18 months and sometimes you feel like tearing your hair out when overvaluation seems as obvious as it is, but the market remains largely blissfully ignorant.
David Buckland
:
Yes Guy,
Our Global team frequently makes the point that US profit margins are at record highs and some argue they mean reverted over past seven decades, as illustrated here: http://rogermontgomery.com/wp-content/uploads/2016/03/Unknown.png
In terms of share of the pie, employers are winning over employees and government (taxes), but this won’t always be the case.
Tristan Harrison
:
Very interesting David.
If resource companies were to be excluded from the S & P 500 earnings decline figure, do you think that the earnings of the rest would have increased? We have heard a lot about the recovery of the USA market compared to the rest of the world, it would be surprising to learn that the company’s earnings don’t match that commentary.
Tristan
David Buckland
:
Hi Tristan,
Energy and Materials account for 6.6 per cent and 2.8 per cent of the S&P 500, respectively.
So the overall numbers maybe slightly positive if we back out the collapse in profitability from these two sectors.
The 8 per cent reduction in earnings expectations for the March 2016 Quarter is rather telling though.