The last two quarters has seen the stock market soaring high. However, there was still something to worry. It is the slow growth rate of corporate earnings. The fact that by most standards the stocks were cheap is very comforting for the bullish investors. Undervalue or overvalue of equities are not important when it comes to predict the market’s direction.
According to strategists, it is not the high price-to earnings that prompt sell-offs rather it is the expectation whether the P/E ratio would grow or not that leads to take the decision. The P/E of the
Standard & Poor’s 500 index jumped from 10 to 13 within six months.
The earnings growth has decreased or its better to say that it has come to a halt. Thus, the companies’ profits in the S & P 500 index are expected to grow only 1% in the 1st quarter and 2% in the second quarter in this year. The expansion in the P/E ratio is the only hope for additional gains in the stock market.
The price-to-earnings ratios have started to fall and the P/E of the index is now 12.5, a fall from 13.
The history of the past 70 years shows that the P/E ratio has increased to more than 30% in the S & P 500 index during the first year of the bull market. The situation is still the same. It is better to calculate taking the average profits of the last five years to analyze P/E ratios. With the same calculation, it is seen that the index is at an all time high at 20.4. Several other factors are there that increase or decrease the P/E ratio.
The S & P Capital IQ is there to track S & P 500 companies’ earnings estimates. It has forecasted that corporate profits would be 5.9% rise in the 3rd quarter and 16.3% in the 4th quarter as compared to 1st and 2nd quarter of this year. Thus, the average estimation for a full year growth rate is supposed to be 6.4%.