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Jeremy Siegel, Ph.D. The Future for Investors

Jeremy Siegel, Ph.D., The Future for Investors

How Cheap Is the Market?

by Jeremy Siegel, Ph.D.

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Posted on Wednesday, April 8, 2009, 12:00AM

On February 25 I published an op-ed piece in the ‘Wall Street Journal' entitled, "The S&P Gets Its Earnings Wrong." In that article I said that, although the S&P weights each individual's stock by its market capitalization to compute the return on the S&P 500 Index, no such methodology is used to compute aggregate earnings of the index.

As a result, the billions of dollars of losses racked up by, say, AIG, whose market value is extremely low, is added dollar for dollar to the earnings of the profitable firms, such as Exxon Mobil, whose market value is more than 20 times larger. I maintained that S&P's methodology gave far too much influence to firms with big losses and low market values, and thereby gave a distorted valuation to the S&P 500 Index.

A Challenge to Standard & Poor's

I proposed an alternative methodology for computing aggregate earnings: Weight the earnings of each company by its current market value, in a fashion identical to the way the return on the S&P 500 Index is computed. This alternative methodology leads to substantially higher earnings for the index than does the S&P methodology.

According to Standard & Poor's, total reported earnings on the S&P 500 index for calendar year 2008 was a mere $14.97, the lowest in many decades, primarily because of the huge losses of a few financial firms. S&P reports that, at the index's level on March 31 of 798, the S&P was selling at an extraordinarily expensive 53.3 times last year's earnings.

Yet S&P's own Web site says that "AIG's record setting Q4 '08 'As Reported' loss of $61.7 billion, or $22.95 per share, took $7.10 off the index." AIG's quarterly loss was so massive that it more than canceled out the entire year's income of Exxon Mobil, which earned $45 billion in 2008. For the full year, AIG lost over $99 billion, more than twice the total profits of Exxon Mobil.

Where the Distortion Comes In

Here is where the distortion comes in. Exxon Mobil has a market value of $350 billion, while AIG's value is now a mere $15 billion (and it was only $5 billion a month ago). That means that the average investor owns more than 20 times as much Exxon Mobil stock in their portfolio as AIG stock, so that for the average portfolio of those two stocks, the oil giant has over a 95 percent share and AIG has less than a 5 percent share.

S&P says that an investor holding 95 percent of his portfolio in Exxon Mobil and 5 percent in AIG has negative aggregate earnings and an infinite price-to-earnings ratio because the losses of AIG are greater than the profits of Exxon Mobil, no matter how much you hold in each. S&P would say this even though 95 percent of your portfolio is in Exxon Mobil, a stock that sells for less than 8 times its earnings.

My methodology would weight the $45 billion earned by Exxon Mobil by 95 percent and the $99 billion loss of AIG by 5 percent to obtain a weighted average earnings of $39 billion for the portfolio. With a weighted average market value of AIG and Exxon Mobil  of $335 billion, this would lead to approximately a 9 P/E ratio for the portfolio, not the infinite P/E computed by Standard & Poor's.

With a few firms sporting huge losses, weighting the gains and losses by market value gives a much better picture of the market's current valuation. Instead of reported earnings of $14.97, the market-weighted earnings is a much higher $71.50, which gives the market a P/E ratio of just over 11 instead of 53.3, as reported by S&P.

The big losses in the financials impact operating as well as reported earnings. S&P reports that total operating earnings for the S&P 500 was $49.49 in 2008, giving the Index a 16 P/E ratio. Once the earnings are weighted by market value, operating earnings rise to about $79.40, giving the market a very cheap P/E ratio of 10.

S&P's Response

After my article appeared, a flood of emails and phone calls came not only to my office but also to Standard & Poor's. David Blitzer, the managing director and chairman of S&P's Index Committee, posted a letter on their Web site defending their methodology and claiming that my methodology "failed the simple tests of both logic and index mathematics. A dollar earned or lost is the same, irrespective of whether it is earned or lost by a big index constituent or a smaller one."

S&P continued, "To use an analogy, we could hypothetically view the S&P 500 as a single company with 500 divisions, with each division having earnings and an implicit market value. The smallest of these divisions could have an outside loss that wipes out the combined earnings of the entire company. Claiming that these losses should be ignored or minimized because they came from a less valuable division is flawed."

What is completely flawed are the logic and economics of the above paragraph. The independent corporations that make up the S&P 500 Index are valued completely differently than if they were divisions of one company. The losses of one company do not cancel the profits of another. Exxon Mobil's shareholders are not impacted by AIG's losses. In fact, AIG's losses are now taken by the bondholders -- or, to the extent the government bails out the bondholders, we, the taxpayers, shoulder AIG's loss. Liabilities do indeed cross the divisions of a single firm, and that is why the New Products Division of AIG tanked the many other profitable divisions of the insurance giant. But these losses do not cancel the earnings of profitable firms.

A Point Well Taken

My good friend and colleague Prof. Robert Shiller of Yale University, who has used S&P earnings extensively in his work, agreed that my point was very well taken. He said that the basic economic principle comes from the theory of options. The value of a firm's equity can be viewed as an option on the total value of the firm, after the bondholders and other claimants have been paid. It is a fundamental theorem of option theory that the sum of the option prices on individual firms is worth more than a single option on the value of all the firms. In other words, the sum of stock prices of 500 stocks must be worth more than "a single company with 500 divisions," as David Blitzer claims the S&P 500 Index represents. This is particularly true if one or more of the divisions has extreme losses, as do AIG and many of the other financials.

Prof. Shiller did say that the theory does not lead directly to my methodology of value weighting, and probably the "true" earnings of the S&P is a far more complicated function of the individual firms' earnings. The true earnings may in fact lead to even higher values than I have calculated. My calculations on historical data show that, in most years, it makes little difference whether earnings are calculated by market value or by using the simple sum as S&P does. This is because when earnings are positive, the two methodologies give similar results.

But as option theory indicates, when the earnings of a few companies turn sharply negative, there is a big difference between the two methodologies. Back in 2002 the aggregate earnings of the S&P 500 Index also plummeted when a few firms, such as AOL and JDS Uniphase, took huge writedowns on some of their Internet investments. Reported P/E ratios soared into the 60s in the second quarter of 2002, yet rather than being overvalued, the market was just approaching its bear market low.

Final Word

The true valuation of the market is no where near as dismal as the aggregate earnings reported by Standard & Poor's suggest. When portfolios of stocks are weighted by market values, the market is cheap by historical standards. No one can say for sure whether March 9 will mark the bottom of this dismal bear market (I personally think it will), but I am sure that investors who hold a diversified portfolio of stocks today will be rewarded by above-average returns.

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  • MarkJ - Friday, April 10, 2009, 12:02PM ET  Report Abuse

    • Overall: 2/5

    Of course in the unusual event of an impending bankruptcy the shareholders are not liable for the debts of the corporation so in that very exceptional case its negative earnings should not be included in the sum. But in general the earnings of investments are dictated by accounting principles. Weighting those earnings by market capitalization is completely arbitrary and doesn't make a lick of sense.

  • Yahoo! Finance User - Friday, April 10, 2009, 11:57AM ET  Report Abuse

    • Overall: 5/5

    Fantastic article

  • Denis - Friday, April 10, 2009, 11:06AM ET  Report Abuse

    • Overall: 4/5

    Professor Siegel is quite right although his reasoning really only applies to extraordinary circumstances like we currently have. See my post S&P 500 INDEX PE AT TROUGHS: A DETAILED 80 YEARS ANALYSIS at http://www.news-to-use.com/2009/03/s-500-index-pe-at-troughs-detailed-80.html. www.news-to-use.com

  • AlanG - Friday, April 10, 2009, 9:41AM ET  Report Abuse

    • Overall: 5/5

    Amazing that half the people who have commented don't understand how the S&P 500 index works. This is fairly simple mathmatics. The same can be said regarding the S&P response to Professor Siegel. I went to the Morningstar site to see how their calculation stacks up (as per the suggestion below). Their value is a prospective P/E of 12 which is a lot closer to Dr. Siegel's than to the S&P value!

  • Yahoo! Finance User - Friday, April 10, 2009, 2:54AM ET  Report Abuse

    • Overall: 5/5

    Brilliant! Someone grab that idiot Kiyosaki and get him to read this. Ahhhh... the benefits of education...

  • Stupifiedbymb - Friday, April 10, 2009, 12:43AM ET  Report Abuse

    • Overall: 5/5

    really amazing. I'd be surprised if Dr. Siegel ever writes another column for Yahoo, given the level of misunderstanding that it has engendered or revealed about how to calculate P/E ratios for indexes: Morningstar does it the right way: http://corporate.morningstar.com/US/documents/MethodologyDocuments/MethodologyPapers/MorningstarPriceRatioAverages_Methodology.pdf

  • Mercy - Friday, April 10, 2009, 12:42AM ET  Report Abuse

    • Overall: 5/5

    I don't know how the good professor could have made this any plainer, but, wow! Reading some of the comments, I have to wonder if these people might be wasting their time trying to understand markets and economics. Of course, when you consider how the Dow Jones is calculated, the guy from S&P sounds like a particle physicist. -Mercy

  • David - Friday, April 10, 2009, 12:24AM ET  Report Abuse

    • Overall: 2/5

    Following are the approximate average values of the S&P 500 from Q2:02, when the author stated the market was just approaching its bear market lows: Q2:02 1069 Q3:02 894 Q4:02 887 Q1:03 861 Q2:03 938 Q3:03 1001 Q4:03 1057 Q1:04 1132 Q2:04 1123 So over the following 2 years the average annual return was 2.52%. The maximum draw down from the Q2:02 average was -27.3%. For the 1 year following Q2:02, there was never a quarter that wasn't at least 10% below the Q2:02. These are the facts. The damage to the economy (and equity values) from past destructive allocations of capital require new, genuine wealth creating activity which inherently will take time to restore the past levels of wealth (destroyed). Is new wealth now being created? How much capital was destroyed? Is there reason to believe that new capital is being created at a faster rate than in the past? Was more capital destroyed than in the previous bear market? . . .

  • Jacob T - Thursday, April 9, 2009, 10:35PM ET  Report Abuse

    • Overall: 4/5

    The point is that if you held an S&P 500 index fund, the Exxon profit would be much more important than the AIG loss, for the simple reason that the fund is market cap weighted, so you hold more Exxon shares than you do AIG shares. Nothing all that controversial (or earth shattering) about it, really. This would be a better article if it gave us a better indication of the influence of this bad metric - - if it were influential, then it may cause the market may be underpriced. However, I suspect that it isn't particularly influential, and therefore, while interesting, this article isn't all that useful.

  • r00t61 - Thursday, April 9, 2009, 6:06PM ET  Report Abuse

    • Overall: 1/5

    This is bogus. For Jeremy to complain about the way the SP 500 is weighted, when the GOV is actively mucking around with accounting (Mark to market) and short sale rules, jobless claims data, and manipulate the CPI so that it doesn't have to pay more benefits to retirees, is a joke. The markets are simple to understand: they're a casino, and the house always wins.

  • Beilin Z - Thursday, April 9, 2009, 6:04PM ET  Report Abuse

    • Overall: 1/5

    I cannot agree more with S&P's response that Mr. Siegel's methodology "failed the simple tests of both logic and index mathematics". Given two companies, company A has a market cap of 1 billion and earns 1 million a year, while company B has a market cap of 1 million and earns 10 million a year, which company do you want to own? Mr. Siegel is telling us that we should own company A since its earning should really be multiplied by 1000 when compared to company B's earning, and is therefore equivalent to 1 billion of company B's earning. I just have a really hard time understanding his (il)logic. This is the problem with some of today's economists. They delve into exotic theories and forget about simple logic and common sense. When pointed out their mistakes, they will throw out fancy terms to confuse people instead of admitting their faults. I guess Mr. Siegel's PhD really stands for "Permanent Head Damage".

  • John - Thursday, April 9, 2009, 4:42PM ET  Report Abuse

    • Overall: 1/5

    This is reminiscent of government redefinition of employment statistics, inflation statistics etc. Strangely, all these redefinitions always seem to make things look better than they would otherwise. All such attempts to redefine metrics are fundamentally bad ideas. For no other reason that it renders comparison to other market cycles impossible. Suppose that the SP500 P/E ratio is redefined to 10 or one. What would this then mean compared to previous market cycles? Nothing. The only valid way to make such a comparison would be to redefine historical statistics as well. Moreover, such distortions as Prof Siegel claims to exist could presumably distort bull market PEs as well as bear. I would think that any arguments for revision would have to show the increased relevance for all market conditions. Otherwise, this could be interpreted as a rather lame attempt to reassure the gullible to buy stocks.

  • Bjossi - Thursday, April 9, 2009, 4:15PM ET  Report Abuse

    • Overall: 4/5

    It is baffling how hard it seems for many people to get the author's point. Imagine your portfolio consists entirely of shares in an S&P 500 index fund. AIG shares are almost worthless at this point and therefore matter little to your portfolio -- the worst that can happen is the shares will go to zero. However, enormous losses at AIG will have a meaningful effect on aggregate earnings and therefore a meaningful effect on the P/E ratio of the index. Is this really that hard to understand or are you just taking your financial frustrations out on Dr. Siegel?

  • suavamente - Thursday, April 9, 2009, 3:11PM ET  Report Abuse

    • Overall: 5/5

    The Market's so cheap....Did you hear about this?....The Market's so cheap, Donald Trump decided to give his hair a raise! A-OH!

  • First - Thursday, April 9, 2009, 2:08PM ET  Report Abuse

    • Overall: 1/5

    He sold his common sense to get his Phd. Here is why: His valuation is based on hindsight which is always 20/20. If I were to invest $1000 today weighted 95% in Exxon and 5% in AIG; and the Exxon's earnings were to drop by 50%, my portfolio will still be cut in half! Valuations have a more practicle purpose than Mr. Seigle's desire to satisfy his stubborn theoritical intellect.

  • AdamL - Thursday, April 9, 2009, 1:19PM ET  Report Abuse

    • Overall: 1/5

    He still does not get it. If I put $1000 into the S&P 500 while more of my money would get invested into Exxon then AIG the fact of the matter is I would have the same percent ownership stake in both companies (ownership was just cheaper in AIG) therefore I have the same % share of AIGs losses as I have % share in Exxon's gains. For him to say you own more of Exxon is a blatent misunderstanding. His methodology is simply a way to try to magnify the upside and downplay the downside.

  • Gracias - Thursday, April 9, 2009, 11:37AM ET  Report Abuse

    • Overall: 2/5

    The S&P 500 is little more than emotional register of the collective hopes and fears of shareholders in the companies listed. It is all about mass social psychology and it is manipulated by market players with a vested interest in making the market seem more positive and vibrant than it really is. Only now, Congress is considering ways to skew the register by prohibiting short sellers. This is like having an applause meter that counts boos as cheers. It is better to enable short sellers than disable them, and one way that can be accomplished is through greater transparency, which unfortunately is currently also being destroyed by the relaxing of accounting valuation standards (mark to market). If we can't have smiles, we will paint them on. If we can't have happy peasants, we will make mannequins. If we can't have rising company valuations, we will simply create them on our books!

  • Jet - Thursday, April 9, 2009, 11:36AM ET  Report Abuse

    • Overall: 1/5

    This is plain ludicrous. I wonder if Jeremy would still propose this if a few small companies made the profit and the large ones were losing money to offset. The total earnings would be the same, but his index would be radically different. The weighting is only for the indexing of the companies. It has nothing to do with profit, size, shares or anything. It is only used to calculate the value of the index. If you think you have a better way to come up with value than the P/E ration then please do use and/or share it. Very few people base their decisions on the P/E alone anyway. But to say the losses don't affect someone investing in the S&P500 index because they are from a (now) smaller company is plain stupid. To argue that the value is better than it appears might have merit. If that is what Jeremy meant to say, he needs to pay attention to his writing skills a bit more.

  • NoiseIsTheBestRevenge - Thursday, April 9, 2009, 11:15AM ET  Report Abuse

    • Overall: 1/5

    Jeremy is incorrect. The S&P500 is a capitalization weighted index. This means that the proportion of the holdings of each constituent company is based on its relative size. Because the index is cap-weighted, the proportions of shares held by the index already vary based on the total size of the firm. In the example above, Exxon already has 20 times the weighting of AIG in the index's value. Yet that company which has 1/20th the market cap still managed to lose enough money to offset the contribution from all of Exxon. Therefore, using the firm's total earnings in relation to the total market cap outstanding is correct. If we were talking about the Dow, Jeremy would have a valid argument, but not for the S&P500.

  • Ian - Thursday, April 9, 2009, 10:51AM ET  Report Abuse

    • Overall: 4/5

    Earnings should be proportional to dollars invested - which might not be the same as market cap. For example, how do you know the total amount of dividends for your tax return? You add them up based on the shares you own. Calculate earnings the same way, it's simple math, but it will vary depending on the mix of stocks.

  • Aubetoile - Thursday, April 9, 2009, 10:16AM ET  Report Abuse

    • Overall: 5/5

    Vinny, the best post ever ! Especially the last sentence ^^ The 5 stars are for you Vinny, not for the clown that wrote this disinformative article.

  • Bing - Thursday, April 9, 2009, 10:11AM ET  Report Abuse

    • Overall: 5/5

    Very good article. If the guy at S&P is any indication of the rest of their company, then it is no wonder why they screwed up the AAA ratings on everything. A diversified portfolio is not the same as investing in a single company with many divisions! Wake up!

  • Yahoo Bill - Thursday, April 9, 2009, 9:58AM ET  Report Abuse

    • Overall: 1/5

    This is the about the dumbest thing I've ever heard. S&P's David Blitzer said it best "failed simple test of logic and index mathematics". Obviously total earnings is the bottom line - sum up the positive earnings, subtract the losses: there's your answer. This column is just another Yahoo "expert" trying to distort data in order to shill for his buddies.

  • Vinny - Thursday, April 9, 2009, 9:58AM ET  Report Abuse

    • Overall: 1/5

    "We will not have any more crashes in our time."- John Maynard Keynes in 1927, "There will be no interruption of our permanent prosperity."- Myron E. Forbes, President, Pierce Arrow Motor Car Co., January 12, 1928, "There may be a recession in stock prices, but not anything in the nature of a crash."- Irving Fisher, leading U.S. economist , New York Times, Sept. 5, 1929, "There will be no repetition of the break of yesterday… I have no fear of another comparable decline." - Arthur W. Loasby (President of the Equitable Trust Company), quoted in NYT, Friday, October 25, 1929, "We feel that fundamentally Wall Street is sound, and that for people who can afford to pay for them outright, good stocks are cheap at these prices." - Goodbody and Company market-letter quoted in The New York Times, Friday, October 25, 1929, "This is the time to buy stocks. This is the time to recall the words of the late J. P. Morgan… that any man who is bearish on America will go broke. Within a few days there is likely to be a bear panic rather than a bull panic. Many of the low prices as a result of this hysterical selling are not likely to be reached again in many years." - R. W. McNeel, market analyst, as quoted in the New York Herald Tribune, October 30, 1929, "The decline is in paper values, not in tangible goods and services…America is now in the eighth year of prosperity as commercially defined. The former great periods of prosperity in America averaged eleven years. On this basis we now have three more years to go before the tailspin." - Stuart Chase (American economist and author), NY Herald Tribune, November 1, 1929, "The end of the decline of the Stock Market will probably not be long, only a few more days at most."- Irving Fisher, Professor of Economics at Yale University, November 14, 1929, "Financial storm definitely passed."- Bernard Baruch, cablegram to Winston Churchill, November 15, 1929, "I see nothing in the present situation that is either menacing or warrants pessimism… I have every confidence that there will be a revival of activity in the spring, and that during this coming year the country will make steady progress."- Andrew W. Mellon, U.S. Secretary of the Treasury December 31, 1929, "I am convinced that through these measures we have reestablished confidence."- Herbert Hoover, December 1929, "[1930 will be] a splendid employment year."- U.S. Dept. of Labor, New Year’s Forecast, December 1929, "…there are indications that the severest phase of the recession is over…"- Harvard Economic Society (HES) Jan 18, 1930, "There is nothing in the situation to be disturbed about."- Secretary of the Treasury Andrew Mellon, Feb 1930, "The spring of 1930 marks the end of a period of grave concern…American business is steadily coming back to a normal level of prosperity."- Julius Barnes, head of Hoover’s National Business Survey Conference, Mar 16, 1930, "… the outlook is favorable…"- HES Apr 19, 1930, "While the crash only took place six months ago, I am convinced we have now passed through the worst — and with continued unity of effort we shall rapidly recover. There has been no significant bank or industrial failure. That danger, too, is safely behind us." - Herbert Hoover, President of the United States, May 1, 1930, "…by May or June the spring recovery forecast in our letters of last December and November should clearly be apparent…"- HES May 17, 1930, "Gentleman, you have come sixty days too late. The depression is over." - Herbert Hoover, responding to a delegation requesting a public works program to help speed the recovery, June 1930, "… irregular and conflicting movements of business should soon give way to a sustained recovery…"- HES June 28, 1930, "We are now near the end of the declining phase of the depression." - HES Nov 15, 1930, "All safe deposit boxes in banks or financial institutions have been sealed… and may only be opened in the presence of an agent of the I.R.S."- President F.D. Roosevelt, 1933

  • Yahoo! Finance User - Thursday, April 9, 2009, 9:36AM ET  Report Abuse

    • Overall: 3/5

    The Equities markets will now jump since we just hit rock bottom. Those who took their money out and put it in bonds and CD's will soon be screaming . Markets are forward looking and the worst is behind us. A Rebound is near and companies are begining to hire. Housing is also rebounding with a record # of homes sold this spring thanks to FHA. We will soon pass the previous market high.

  • Maria - Thursday, April 9, 2009, 9:16AM ET  Report Abuse

    • Overall: 1/5

    Thanks for the article. Do you think investors who hold a diversified portfolio will be rewarded with the same type of returns they've had for the last six months?

  • Yahoo! Finance User - Thursday, April 9, 2009, 8:58AM ET  Report Abuse

    • Overall: 4/5

    To the tax payer, who bears the burden of providing the last resort to failed markets, 500 firms will look like 500 divisions within a firm, as they are all in the same economy. Even that is inaccurate, as these 500 firms have significant foreign earnings. To the private investor, the same metaphor does not apply. However, the roles of tax payer and private investor are not separable for a US tax payer. A non-taxpayer such as a foreign person, can take an exclusive private investor view as he/she does not bear the last resort burden. The flaw is discussing this in absolute terms. It is relative depending on your role & responsibility in the market.

  • Will - Thursday, April 9, 2009, 8:58AM ET  Report Abuse

    • Overall: 2/5

    Siegel's idea is interesting, but he is wrong on a couple of points. 1) Investors do buy the S&P500 like one company when they buy Spyders and other ETFs and mutual funds that largely include the S&P500 stocks. This is not limited to index based investments, but also includes investments in large managed funds like American Funds Growth Fund of America, which must hold most of the S&P500 in a reasonable proportion just to invest the huge amounts that they manage. 2) It is wrong to weight a company's yearly earnings by the company's year-end percentage in the index. The earnings should be weighted by the average market value weight for the year. Either I missed this or Seigel may have left this out on purpose to simplify the argument.

  • GP - Thursday, April 9, 2009, 8:55AM ET  Report Abuse

    • Overall: 1/5

    The math is all wrong and the thinking is garbled. Mr Siegel is confusing value with earnings. If you look at the aggregate S&P 500 (many people just hold the index or mutual funds that, in aggregate, follow the index), the profits were, indeed, dismal. It doesn't matter that the firms that fell might be smaller. If you owned 1% of the S&P 500, you'd have seen very meager profits (though you'd still be extremely rich). Mr. Siegel proposes distorting the EARNINGS to show the true value of the index which doesn't make any sense at all. In his example, if you owned equal portions of Exxon and AIG, the earnings of your stocks is dismal and should not be distorted. However, if you are looking for the VALUE of the index, some sort of distortion might make sense. It is unlikely that AIG (now a small company) can hurt the earnings in the future as much as it did last year. As such, a complicated formula to estimate the value might make sense. The S&P guys made the correct response as they are measuring the earnings, not the value. No one should distort the earnings in order to determine the value of the index. The two items are not the same. As such, there isn't any reason why you can't use a complicated formula for value. There is, however, a strong reason to not distort the earnings in that they accurately reflect what happened in the past.

  • David - Thursday, April 9, 2009, 7:57AM ET  Report Abuse

    • Overall: 5/5

    The author realizes the approach he suggests isn't the "right" way to do it but rather the "sane" way. I wish he would have used this example though: If one company on the S&P had trillions upon trillions in losses and all other companies were profitable in the billions... the existing S&P method would show the value of the S&P earnings as negative whereas the proposed method would better call out that 499 companies have value and 1 is worthless. That is the important part here... that the value of any of the crappy companies shouldn't impact the positive value of the others that aren't! In the real world the value of that one company goes to zero... in the add-the-earnings approach it is allowed to impact the index as if its value could be negative... very, very foolish!

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