The widespread belief in the market today is that the earnings will slow down in the coming year. The headlines in the financial sections of the newspapers are filled with rising oil prices and housing bubble stories. Overall market is expecting bad news from the economy and is ready to dump the stocks as soon as some bad news comes forward. In this rocky market situation, we need to take a step back and re-evaluate the impact of slowing earnings on the equities.
Let’s not consider the slow earnings growth for now. Let’s take it a step further and consider for a moment “no” earnings growth for the next five years in the S&P 500 index. This year in 2005, the expected earnings estimate for S&P 500 is $75.02 on as reported basis. Now assume that for next 5 years, from 2006 to 2010, S&P 500 earns $75 each year. Even in this static situation the total earnings for the next 5 years will be $375.
So, “no” growth gives you $375 for next 5 years.
The current price we are paying for S&P 500 is about $1200 for $75 earnings each year. The inverse of the P/E ratio, the E/P of S&P 500 is 6.25%. In a “no” growth environment the index investment can be considered as a bond with 6.25% yield. The current 10-year bond yield is about 4% and 30-year bond yields about 4.30% for comparison purposes.
All disclaimers apply.