Sunday, March 9, 2014

The Danger With Wall Street's Projected Earnings

The following excellent chart from STA Wealth shows the estimated trajectory of earnings heading into the two previous U.S. stock market peaks in 2000 and 2007. Using these estimated earnings, the P/E ratios looked fair to undervalued at the absolute peak of both tops.


Fast forward to the present day in the chart above and you can see the exact same scenario has repeated (only the estimates are violently more optimistic). Earnings are forecast to grow by 50% over the next two years from $100.28 per share to $147.50 per share.

Investors buying U.S. stocks at "fair value" today are paying for future earnings that may never arrive. Can you see the potential danger?

The only scenario under which stocks can continue to rise higher is for the incredible projected earnings growth to actually arrive combined with new investors willingness to overpay for those earnings. Any bump in the road will lead to disaster.

After five years of cyclical earnings growth combined with P/E expansion the more likely scenario is that earnings come in below the lofty forecasts and sky high real P/E ratios fall.

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