In this unique primer, Edward Yardeni and Joseph Abbott, two of the world’s most experienced and widely followed investment strategists, provide investors with a practical understanding of the forces that drive the stock market. This study focuses on the S&P 500 stock price index, examining how it is determined by the earnings of the 500 companies that are included in the index and the valuation of those earnings by the stock market. Notwithstanding occasional bear markets, the S&P 500 has been a great investment over the years-so much so that S&P could stand for Success & Profit.
The first chapter in this study covers the various measures of earnings for the S&P 500 and why they favor forward earnings among them. The second chapter discusses various models of valuation, again focusing on the S&P 500.
The final chapter uses the resulting analytical framework to review how it has worked in good times and bad, focusing on the Great Financial Crisis and the Great Virus Crisis.
The market discounts analysts’ consensus estimates for revenues and earnings this year and next year on a time-weighted basis. Calculating weekly forward revenues and forward earnings from analysts’ estimates can provide very timely insights into the performance of the global economy as well as the underlying trends in quarterly revenues and earnings.
While this framework provides a disciplined approach to analyzing the macroeconomic fundamentals that are driving earnings, the valuation of those earnings by investors will continue to be much more subjective than objective. Nevertheless, there are fundamental factors that influence valuation multiples. Some, like inflation and interest rates, will always be important in assessing the valuation question. Other factors may be relatively new and worthy of careful analysis.
