It's Not All Bad

8/19/2013


There is no shortage of reasons to be bearish, from turmoil in the Middle East to dysfunction in the U.S. political system. But the central contentions of many bears — that U.S. stocks are floating higher wholly because of easy money from the Federal Reserve, that yield-starved investors are looking past dangerously rich valuations and the lack of profit growth because they have nowhere else to turn — is not supported by the facts.

Per-share profits for the capitalization-weighted S&P 500 Index are on pace to be up 4.7% to record levels for the June quarter, according to Thomson Reuters, and the picture looks brighter if you consider the opportunities in individual stocks:

• Among companies in the S&P 500, the median change in per-share earnings in their most recent quarter was 7.7%, meaning half of S&P 500 members delivered at least 7.7% growth. For the most recent 12-month period, the median increase was 7.6% — below the norm of 9.9% since 1994 but not disastrous considering the pace of global economic growth. If global growth accelerates next year, as consensus forecasts predict, so should profit growth.

• While per-share earnings are being helped by aggressive share repurchases, the median S&P 500 sales change in the most recent quarter was 6.0%, in line with the norm of 6.1% since 1994. For the most recent 12-month period, the median sales change was 5.2%, below the long-run norm of 7.3%.

• The median trailing price/earnings ratio for S&P 500 stocks is about 19, versus the norm of 18 since 1994. Valuations are richer outside the large-company S&P 500, but the median P/E is within 15% of historical norms for the S&P SmallCap 600 and S&P MidCap 400 indexes.

• About 58% of S&P 500 stocks have trailing P/Es below 20, matching the norm since 1994. However, the number of truly cheap S&P 500 stocks is below historical norms, with only 21% of stocks trading at a P/E below 14 and 13% below 12.

Conclusion

Stocks are not cheap; based on most valuation ratios other than dividend yield, the median stock in the S&P 500 and broader S&P 1500 trades at a premium to 10- and 20-year norms. But bull markets tend to end when stocks are downright expensive, and current valuations compare favorably to prior bull-market peaks.

More important, we are still finding names that fit our growth-at-a-good-price approach. For stocks on our Buy List, the median P/E based on next-year expected earnings is 13 — lower than about two-thirds of U.S. stocks. Yet most of our Buys delivered above-average earnings growth in the two most recent quarters. For now, with quality stocks available at reasonable valuations and the Dow Theory squarely in the bullish camp, our buy lists have at least 94% in stocks.

S&P 500 VALUATION BREAKDOWN
-------- % Of S&P 500 Stocks With Trailing P/Es Below --------
12
14
16
18
20
22
Recent percentage (%)
13
21
31
44
58
67
             
Norm since Oct. 1994 (%)
17
27
38
49
58
65
             
Minimum since Oct. 1994 (%)
4
7
14
23
30
36
Maximum since Oct. 1994 (%)
60
71
76
81
84
86
             
% of months lower than recent
37
30
30
34
56
52
About 44% of stocks in the S&P 500 have trailing price/earnings ratios below 18 — below the norm of 49% since 1994 but well above the 19-year low of 23%. The percentage has been lower than 18 on 34% of the month-ends since 1994.

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