THE BOTTOM LINE
- The sudden downturn in stocks this past week had a dramatic impact on valuations. Stocks are now trading at a significant discount to valuations early this year.
- Based on expected earnings, the S&P 500 is now trading at a P/E of 16.8, about 10.4% below its level on January 26. But over the same interval, the S&P 500 fell some 5.0%,1
- In effect, the P/E has gotten 5.4% more attractive than the falling price alone would warrant.
- In addition, a P/E of 16.8 is notably below the five-year average P/E of about 17.4.
- The source of this intriguing discount: increases in the overall expected earnings power of the companies in the index.
- As the current earnings season begins, it’s worth recounting the key drivers of the improvement, including lower corporate taxes, strong overall economic growth, and boosts to profitability from declining raw materials prices and relatively moderate growth in wages and other components of employee costs.
- When added to corporate stock buybacks and a surge of earnings-accretive mergers and acquisitions, there remains a case for solid fundamentals as well as longer-term value.
- That’s not to deny the headwinds facing the global economy – uncertainty about the impact of rising tariffs, rising rates in the U.S., geopolitical tensions and other familiar concerns.
- But when strong fundamentals meet market anxieties, opportunities for appreciation can emerge for astute, valuation-sensitive active investors. Seen another way, worry sometimes sets the stage for future gains.
1 As of close of trading on Thursday, October 11, 2018. Source: Bloomberg.
Unless otherwise noted, all data Source: Bloomberg, as of October 11, 2018
The price-earnings (P/E) ratio is a stock's (or index’s) price divided by its earnings per share (or index earnings). The forward or estimated P/E ratio is a stock’s (or index’s) current price divided by its estimated earnings per share (or estimated index earnings), usually one-year ahead.