Earnings and Investor Sentiment

In the stock market only two things matter. The earnings a company produces and the price investors are willing to pay for them. The former is simple, every quarter the company releases their prior quarter/year’s earnings and gives a forecast of what they expect their next quarter/year to look like. For the most part it’s hard math, with of course some inconsistency in the forecasting.

But the problem lies within the latter. What investors are willing to pay. And I say that because people are, at times, irrational beings, and so at times investors are irrational. Regardless of where earnings are at or where they are going investors can price the stock market up or down depending on how they feel, versus the hard facts.

Sometimes this pricing is met with actualization. For instance if investors are pricing the stock market up because they feel the forecasters are more pessimistic than reality, at some point their may be a realization that the forecasters were wrong and the market was right. On the other hand the forecasters may say that the future is full of sunshine and rainbows, but the investors are pricing down the market because they are on edge about some uncertain future.

This chart does an excellent job of visualizing this.

Right now Goldman, the forecaster, predicts a 2024 FY $237/share earnings on the S&P 500 and an accompanying 17x earnings that investors would be willing to pay for those $237 in earnings.

However in reality, as show in the below chart, investors are willing to pay 18x. Currently the S&P 500 is around $4,200, which checks out with the chart above at around an 18x forward earnings price.

To throw another wrench into the process this is only Goldman Sachs research. Consensus, as shown in the top chart, puts $4,150 as the 17x forward estimate because of the FY 2024 $245/share earnings forecast. Making either Goldman’s 17x multiple right, but their earnings per share wrong, or making Goldman’s earnings per share right and multiple wrong.

This is why we rarely try to time the market. Emotion plays a crucial role in what the price on the market will be in the next 6 months even.