I bet that you, like me, get a number of client calls that reference a Wall Street report touting forward P/Es. The client watched an analyst on TV saying P/Es are cheap based on next year’s earnings estimates. The analyst compared that forward estimate based P/E, which is 17.20 as of August 31, 2016, to 23.7 (median P/E) or 26 (Shiller P/E) and says the market is not so richly priced.
Not only is that poor analysis, if you look at forward P/E and compare it to other periods in time, you’ll see that the current level is as high as it was in 2007 and higher than any other period since the 1960s with the exception of the late 1990s and early 2000s.
With that said, here is the main reason I don’t rely on Wall Street “consensus” earnings estimates. The next chart shows year by year where Wall Street’s estimates began and where they finished up. For example, look at the 2016 estimates (orange line). Back in March 2015, the consensus earnings estimate for 2016 was approximately $137.50 in operating earnings per share for the S&P 500. The most recent estimate, as of August 24, 2016, is $110.84 per share.
Take a look at each year. Note how it started high and how much it declined by the time the actual numbers were reported. Keep in mind we won’t know 2016 numbers until Q1 2017. And we won’t have 2017 numbers until Q1 2018. My simple point is… how can we rely on forward P/E based on Wall Street’s earnings estimates? I can’t.
Click here to find out what actually happened with consensus estimates.