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The Future of Corporate Profits. The “E” in the P/E Equation

February 8, 2007

AUTHOR:

As margins revert to the historical average, corporate earnings growth will either decelerate — disappointing Wall Street expectations of 8% earnings growth for the S&P 500 over next five years — or decline, driving earnings, the “E” in the P/E equation, down.

I wrote this article last year, on the risk that high corporate margins present to investors. Here is updated excerpt from that article:

Today’s stock market valuation is higher than it may appear. As margins revert to the historical average (and they always do), corporate earnings growth will either decelerate — disappointing Wall Street expectations of 8% earnings growth (according to First Call) for the S&P 500 over next five years — or decline, driving earnings, the “E” in the P/E equation, down. The broad market index fund investor may be in a pickle when a cheap market suddenly becomes more expensive. If today’s corporate profitability reverts to the mean profit margins observed over the last 25 years (8.8%), corporate profits would decline almost 31%.

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