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Forward earnings tell you nothing about value [ClearOnMoney]
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Forward earnings tell you nothing about value

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Commentary

Forward earnings tell you nothing about value

1 Sep 2010 by Jim Fickett.

There is no correlation between forward P/E and actual returns over the following 12 months.

There has been much comment suggesting that forward earnings, that is, earnings estimated for the coming year by stock analysts, are too optimistic, or are just an extrapolation of past trends. And both of these criticisms are correct. But the real question is whether, despite any objections, forward earnings tell you something important. Certainly many current articles feature the argument that stocks are underpriced, given the earnings that are expected.

The Financial Times reports that Lombard Odier, a private bank, did the analysis, and they pass on the original client report.

Lombard Odier measured the correlation between (1) forward P/E (that is, the price to earnings ratio, calculated using forward earnings), and (2) real total return over the following 12 months. If the forward P/E had any value, you would expect a negative correlation – an expensive P/E would result in low returns, and a cheap P/E would result in high returns.

There is no meaningful correlation.

For the emerging markets MSCI index, the correlation is 0.0 and the scatter plot appears to be completely random. For the S&P 500 there is a very small, but not practically useful, correlation (R2 = 0.1).