Investment Matters

The key point in all this is that Analysts can’t predict short term profitability.

Every year, almost without fail, poor old analysts (and economists) trudge to work and predict profits will rise in the next quarter and year ahead. Whilst these forecasts can contribute useful insights into how businesses operate, they are seldom right.  Sometimes to an extraordinary level.

As it currently stands analysts are predicting a return to very strong US profit growth – this time next year US profits per share should be 22% higher (according to data compiled by S&P and publicly available). This would be wonderful if this was not what analysts had broadly expected every year (and then subsequently revised down as the year wears on, every year).

Whilst it is great to be optimisitic, the degree of error is such that investing based on analysts' growth expectations has not proven helpful in building wealth over the longer-term.

Instead we would recommend paying attention to the price you are paying for your shares today based on current profitability(assuming that profitability is real and not just accounting haze).

Even if earnings should fall for a while (for instance you have regrettable timing and invest right on an economic and earnings recession) most good businesses can return (in better times) to the prior level of profit (and proceed to new highs). It’s not a hope thing, it’s demonstrable.

In this regard, the value of the US share market (and to be fair most shares globally) currently gives us cause for concern, and continues to force us into an extremely defensive portfolio position.

Below you can see that the US market is sitting on a value which is equivalent to 22 times its current earnings (the “Price-Earnings ratio”). Apart from the Dot Com mania and the Global Financial Crisis collapse in earnings (both events had collapsing corporate profitability versus likely longer term profits and thus giving a very high P/E ratio - the two big spikes on the chart), this is a very high level reached only twice before (this data goes back to 1926 and is inflation adjusted).

US PE

Whilst historically a high P/E has not necessarily signalled that a significant fall is imminent, this did occur in several notable instances:

 

  • 1929 - market P/E = 20.2 at peak
  • 1987 – market P/E = 21.1
  • 2000 – market P/E = 29.4

 

But the much more common (and therefore likely) outcome is a market that produces low returns for a long period of time.

So buyer beware, it is time to consider your investments accordingly.