Why You Should Value the S&P Using “As Reported” Earnings Data
When people quote analyst earnings expectations, they are usually referring to “operating” earnings which adjusts “as reported” (GAAP) earnings for non-recurring items. People use operating earnings because they show a cleaner picture of results that is more comparable to past or future periods. If the charges are one-time in nature, they don’t necessarily have to be counted in future projections.
This makes sense for an individual company; however, when you look at the S&P 500 as a whole, it’s not so valid. That’s because when you aggregate the S&P 500, “unusual” charges end up becoming “usual” charges that should be expected to repeat in the future. One-time charges will come different companies in different periods, but in aggregate a baseline amount of charges should be counted on to detract from earnings.
As shown in the chart above, “as reported” earnings has consistently been below “operating” earnings for the last 25 years. In recessions, unusual charges tend to run at greater levels than in flush times, but unusual charges outweigh unusual gains even in boom times. In other words, you can count on one time charges happening in every period.
In the median trailing twelve month period, as reported earnings trail operating earnings by 10%. That’s the “usual” amount of “unusual” charges. Because unusual charges do fluctuate, it might make sense to normalize operating earnings by adjusting them lower by 10%, but it doesn’t make sense to leave operating earnings alone completely because that assumes that these one time charges wont keep happening.
If you adjust by 10%, adjusted operating earnings would still be higher than as reported earnings during recessions (when one-time charges tend to run higher), but adjusted operating earnings would be lower than as reported earnings during booms when one time charges tend to be less prevalent. This methodology is more consistent with why analysts are excluding one-time charges to begin with. Currently, as reported earnings are only 7% below operating earnings ($103.68 vs. $111.67), which suggests that the “normalized” earnings number for the S&P 500 should be lower than as reported earnings.
This has important implications for market valuation metrics. Forward earnings multiples are based on operating earnings as well. “Non recurring” charges represent the difference between the S&P selling for 17.2x operating earnings and 18.5x as reported earnings. If normalized earnings are assumed to be 10% less than the value of operating earnings, then current normalized earnings are $100.50, which means the S&P 500 trades for 19.1x.
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