When stock prices rise faster than earnings, you are witnessing something called earnings multiple expansion. In other words, stocks are getting more expensive.
Earnings multiples have expanded and contracted since the beginning of the stock market.
Unfortunately, if you have been a stock market bear lately banking on falling earnings growth expectations, then your prediction has only been half right.
In a new report, FactSet’s John Butters takes a brief look at evolving Q2 earnings expectations, which have only been coming down for months.
“The Q2 bottom-up EPS estimate (which is an aggregation of the estimates for all 500 companies in the index) has dropped 3.4% (to $26.52 from $27.45) since March 31,” writes Butters.
This has occurred as stocks have only been going up. And according to Butters, this dynamic is not that unusual:
Is it unusual for the earnings estimate for the index to decline and the value of the index to increase during the first two months of a quarter?
In recent quarters, it has not been unusual for the value of the index to increase at the same time analysts are trimming earnings estimates for the same quarter. In fact, it has occurred in 9 of the past 20 quarters (including Q2 2013). During these nine quarters, the average decrease in the bottom-up EPS during the first two months of the quarters has been 4.7%, while the average increase in the value of the index during the first two months of the quarter has been 6.8%.
Some warn that this trend of stock prices rallies with no earnings growth is getting dangerous for investors. But for now, it’ll continue to make the bears look like fools.
Here’s the chart from FactSet’s John Butters:
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