Wednesday, December 3, 2008

S&P... emphasis on the Poor's

S&P has been busy this last quarter.

I don’t download the SP500EPSEST.xls file every day but probably every couple of weeks, I check it out to see what’s changed. Unfortunately, I haven’t been able to find any source of data that watches the forecast changes from S&P over time. (If anyone knows of one, please let me know.) Every time I’ve opened the file, the revision to Q4 earnings has been negative.

The chart here shows just how drastically the operating EPS estimates have been cut from early September until the present. The quarter ending on 6/30 reflects actual data reported and the 11/12 value for the quarter ending on 9/30 is also real reported earnings.

But it helps to contextualize these revisions. So, the next two charts that illustrate this well. The first shows operating EPS (operating omits write-offs/downs) on a linear scale from 1988 to Q4/2009. The second is the same chart but with a log scale for the EPS side only. The pink line uses the actual operating EPS data. (SPX data was only included up to the end of the actual EPS data series and so stops on 9/30/08.)

Clearly, the revisions downward are reflective of the reality of this most recent quarter’s results. What is most intriguing is the expectation for growth in 2009 that is still built into these forecasts. The linear scale in the first chart shows the steeper slope of these forecasted EPS numbers compared to the entire period of 1988-present. This seems absurd in the face of a mounting recession and the deleveraging occurring. But again, it helps to have context.

Going back to the linear scaled chart, the period marked out from points 1 to 2 (Q2/92-Q2/98) had an average quarter-to-quarter percentage growth of 3.54%. The period marked out between points 3 and 4 (Q3/01-Q3/06) notched average quarter percentage growth of 4.63%. The average forecasted percentage growth rate for Q4/08 to Q4/09 using the most recent S&P forecast is 7.60%!

Making a somewhat optimistic assumption of quarterly EPS growth being an average of the 1-2 and 3-4 periods (4.08%) reduces the forecast considerably.

The forward PE for S&P's forecast at 850 is 10.51. For the reduced forecast it is 11.73. AQR's Cliff Asness has estimated forward PEs have historically been around 11. Considering the optimism of S&P's estimates and how much they've been revised downward, assigning a fair value to SPX at this point would be tricky at best. I'll revisit this in the future with respect to historic yields and PEs a bit more.