Stocks Could Rise By As Much As 10% Before Being Fairly Valued

We are now about halfway through earnings season with 42% of companies within the S&P 500 having reported results. According to data from Dow Jones S&P, 71.3% of companies have beaten their estimates, while 23.6% have missed, and 5.1% have met. It sounds like an extremely bullish report, but those results are much worse than the previous two quarters. In the second quarter of 2018, 80% of companies beat estimates and just 14.8% missed.

However, when we dig a bit deeper into those numbers, we find that historically going back to 2012, the range of 70 to 75% of companies beating estimates is within the higher end of the norm. Last year's high number of beats may have been because of the new tax law changes, and now that those changes are normalizing the number of beats and misses are returning to their historical trends.

earnings growth S&P 500  stocks

(Data from Dow Jones S&P)

Earnings Estimates Fall

Earnings estimates for 2019 continue to decline. Currently, forecasts are calling for growth of roughly 7.8% earnings growth in 2019 to $167.64 per share. That is about 5.3% off the August highs of $177.07. Estimates for 2020 have also fallen to around 190.79, and suggest growth of 13.8% in 2020.

earnings growth, S&P 500

(Data from Dow Jones S&P)

Valuations Rise

With the S&P 500 rising sharply off the lows and estimates falling, the PE ratio of the S&P 500 has increased to 16.1 times 2019 earnings estimates, and 14.2 times 2020 estimates.

Throughout much of 2018, the S&P 500 traded at 17.5 times forward earnings. If the market should repeat that trend, the S&P 500 could rise to around 2,930. Additionally, the index traded at roughly 15.5 times one-year forward earnings, should that happen this year it would suggest the S&P 500 rises to 2,957 using 2020 estimates. It does assume that earnings estimates do not continue to fall meaningfully. Both outcomes would suggest there is about 8.5 to 9% more upside in the S&P 500 for it just to get back to a reasonably fair valuation. At this point, the S&P 500 valuation still seems too low.

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Disclaimer: This article is my opinion and expresses my views. Those views can change at a moment's notice when the market changes. I am not right all the time and I do not expect to be. I ...

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