Last of a three part post on market fundamentals.
The SP 500 Market Tracker based on 12 months eps through
3/10 sits at 1060. The market is currently trading at a 10%
premium to the Tracker. The spread is not onerous.
With rebounding earnings and rising estimates, the market is
discounting continuing strong net per share performance into the
third Q of 2010. Again, not unusual.
The Tracker, based on a full year consensus estimate of a touch
over $78 per share, would fetch a value 1290 for the SP 500 by
late in 2010. Since advance indicators point to sharply rising
recovery eps into Q 3, this is probably a reasonable enough
So far, investors are showing no concern about the issues of
exiting accomodative monetary policy and strong fiscal stimulus.
Both issues could arise as concerns later in the year.
The Market Tracker based on super long term trend earnings
gives a "500"value of 1155 for 2010 and 1230 for 2011. So, for
investors with a longer term time horizon, the market is now
fairly valued. This means that the chances for sizable excess
returns depends entirely on continued strong earnings gains and
a moderate level of inflation (not in excess of 3.5% per).
I also use a simple dividend discount valuation model and a
kindred p/e assessment model based earnings plowback. The
dividend discount model reveals that investors are expecting a
cyclical recovery of the dividend and that players are also
factoring in earnings / dividend growth of between 7.5 -8.0%
long term. From an economic perspective, this would imply
top line growth of 6.0 - 6.5% plus further profit margin
improvement. That would represent a tall order if the USA was
the exclusive focus. So, implicit in investor's minds are continued
aggressive balance sheet management such as share buy-backs,
and the benefits of increasing SP 500 exposure to faster growing
emerging and developing economies with lower cost structures.
Clearly, investors do not have humble expectations.
Over the past 20 years, companies have allowed dividend
payout ratios to decline and have increased the ratio of earnings
plowed back into the business. Return on Equity % x earns.
plowback rate = implied internal growth. Excluding the recent
recession years the formula would run as follows: 15% x 65% =
9.75%. That would imply a p/e ratio over 20x trend eps.
Investors, seeing that few companies can grow by over 10%
a year, have not bought into the corporate strategy since the
bubble days of 1996 - 2000. And, they have been correct to be
more conservative. In fact, I suspect that earnings and market
performance for the SP 500 would have been more stable had
companies payed out more in dividends than they have.