For March 2015, we look at U.S. corporate earnings and discuss the dynamics of the most widely used method of equity valuation, Price to Earnings.

1. Market Perspectives – March 2015
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Overview: With fourth quarter earnings season largely complete, it is timely
to reflect on corporate profits for 2014 and look forward to 2015. This month
we look at the path of U.S. corporate earnings and explain the dynamics of
the most widely used method of valuation, P/E, or Price divided by Earnings.
Monitoring Earnings

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Back to the Basics
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• What is P/E? “P” is the price of security and “E” is the earnings stream over some period of time,
typically a year. It is the cost an investor is willing to pay for a company’s earnings. When price is
divided by earnings, the result is a P/E multiple.
• The range of P/E multiples for individual companies vary greatly. A company’s P/E is mostly
determined by its ability to grow its earnings over time. For example, a company who competes in a
very mature and capital intensive business will typically trade at a lower multiple. Conversely, a
company with large market opportunities and low incremental costs to grow will tend to garner a
much higher multiple.
• When a stock price advances, either the P/E multiple rises, or the earnings grew. For example, if a
stock is trading at $100 per share, and the stock is earning $5 per share, then the P/E is 100 divided by
5, or 20x. If the stock price moves to $150, either the earnings grew or the P/E multiple grew. If
earnings grew from $5.00 to $7.50, then the stock would still possess a P/E multiple of 20x, or 150
over 7.5. If the earnings did not grow and remained at $5 per share, and the stock grew to $150 then
the P/E multiple would have expanded to 30x, or 150 over 5. In other words, the stock is more
expensive because the market went from being willing to pay $20 for a dollar of earnings to $30 for a
dollar of earnings.

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Where are Current P/E Multiples?
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• Examining the S&P 500
companies together, the
picture gets clearer. The
typical P/E multiple for the
S&P 500 over time
averages in the 17x range.
• This chart represents the
world’s major markets and
corresponding multiples.
• As you can see, the U.S. is
trading just under 18x
2015 consensus earnings
estimates, a slight
premium to history.

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Market Multiple
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• The S&P multiple is currently above the 60 year median P/E of 16.7x
• Wharton Professor and noted market observer Jeremy Siegel recently wrote about the key reasons:
• Higher multiples are justified in today’s ultra-low interest rate environment.
• 2015 earnings estimates have been slashed at a magnitude typically reflective of recessions due
to a stronger dollar, the collapse of energy prices, and the sharp rise in pension obligations.
• The next few slides examine market earnings or the “E” in more detail.

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What Sort of Earnings Growth Have We Seen?
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With 4th quarter earnings reports almost complete, S&P
500 earnings growth for the 4th quarter was just under 5%.
For the full year 2014, S&P earnings grew just over 6%.

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What Does the Future Hold?
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The next several quarters (to the right of the thin, vertical
line) show negative growth for the first time in many
quarters.
Full year 2015 consensus estimates show just 1.2% growth,
which is substantially lower than we have seen the past
several years.

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Why is this Important for Clients?
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• For markets to continue to advance, we must see multiple expansion and/or earnings growth.
• With interest rates and inflation low, we may see multiples continue to expand. That said, in recent
years we’ve seen multiples expand from the low double digits to the mid/high teens. In order for
multiples to continue rising, it would likely take an acceleration in growth beyond current forecasts.
• The current consensus estimates suggest that earnings growth may be more challenging. S&P 500
earnings are projected to grow just 1.2% in 2015. We are cautious on the forecasts in that they have
been consistently wrong. However, the direction of change is cause for some level of concern.
• In light of the earnings projections, U.S. equities appear to be within the range of fair value on a
historical basis. We remain nimble and are closely monitoring earnings, expectations and the variables
that enter the equation in evaluating the current environment.

8. Market Perspectives – March 2015
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Conclusion: As suggested in the past, valuations and earnings are critical
to our process. Our goal in managing assets is to allocate capital where
valuations look reasonable, while accounting for growth. We strive to
remain flexible in our approach and revisit our investment thesis as
conditions change.
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9. Opinions expressed in this commentary may change as conditions warrant and is for informational
purposes only. Information contained herein is not intended to be personal investment advice for any
specific person for any particular purpose. We utilize information sources believed to be reliable, but
cannot guarantee the accuracy of those sources. Past performance is no guarantee of future
performance; investing involves risk and may result in loss of capital. Consider seeking advice from a
professional before implementing any investing strategy.
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Disclaimer
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