4 Things Investors Need to Know About the Best Earnings Season in 12 Years: Part 2

4 Things Investors Need to Know About the Best Earnings Season in 12 Years: Part 2

Posted On July 2, 2021 12:58 pm

In part one of this series, we saw why Q2’s earnings growth is potentially going to be the best we’ve seen in 12 years, and might ever see again, at least within our lifetimes.

We also saw why analysts are so bullish about earnings growth in the medium and long-term, with earnings growth that’s potentially 50% above its historical rate.

Now I want to highlight the two most important facts that determine how your portfolio likely does for the rest of 2021 and far beyond.

Fact 3: Earnings Growth MIGHT Be Enough To Prevent A Bear Market But Don’t Count On It

Year EPS Consensus YOY Growth Forward PE Blended PE Overvaluation (Forward PE) Overvaluation (Blended PE)
2020 $138.01 -13.93% 26.6 26.0 59% 50%
2021 $192.93 39.79% 22.2 24.4 33% 41%
2022 $214.90 11.39% 19.9 21.1 19% 22%
2023 $230.12 7.08% 18.6 19.3 11% 11%
12-Month forward EPS 12-Month Forward PE Historical Overvaluation PEG 20-Year Average PEG S&P 500 Dividend Yield 25-Year Average Dividend Yield
$192.56 22.231 33.04% 2.62 2.35 1.45% 2.04%

(Source: Dividend Kings S&P 500 Valuation Tool)

Based on blended earnings, both trailing and forward-looking, it’s a historically expensive market.

In fact, other than the spread between corporate bond yields and earnings yields, the market is extremely overvalued by basically every metric.

This is why the media is so happy to bring us perma-bear forecasts about epic crashes, such as GMO, which is forecasting -7% CAGR total returns for stocks over the next 7 years.

In other words, stocks in seven years will be 40% lower than they are today, including dividends.

And such dismal forecasts look tame compared to such famous perma-bears as John Hussman.

Mr. Hussman, who became famous after the Tech and Financial Crises, has predicted as much as a 70% crash in the market.

Fortunately for most investors, such dire predictions are not anywhere close to the blue-chip consensus.

JPMorgan’s blue-chip economists are forecasting about zero returns over the next five years.

Compared to a 40% crash that seems like heaven. Compared to the 14% CAGR we’ve seen over the last 10 years, it would probably feel like hell for most investors.

A recent survey of investors around the world found that they expected about 17% annual returns over the next decade, higher than the last decade, which was one of the best bull markets in US history.

FactSet Consensus Total Return Potential

Year Upside Potential By End of That Year Consensus CAGR Return Potential By End of That Year Probability-Weighted Return (Annualized)
2021 -21.39% -37.03% -27.77%
2022 -10.79% -7.24% -5.43%
2023 -2.76% -1.11% -0.83%
2024 7.18% 1.99% 1.49%
2025 17.96% 3.72% 2.79%
2026 29.66% 4.82% 3.49%

(Source: Dividend Kings S&P 500 Valuation Tool)

Analysts, in general, expect close to 5% annualized total returns, and 6% from the dividend aristocrats.

In other words, not as bearish as the doomsday prophets warn about, but less than 1/3rd of what most retail investors expect.

What if earnings continue to beat expectations this year? Might that not improve the short to medium-term market return outlook?

That’s certainly possible. At the start of the year stocks traded at 23X forward earnings. After a nearly 15% rally, earnings growth has been so strong that stocks trade at about 21X forward earnings.

If earnings were to beat expectations for the rest of the year by the same 23% we saw in Q1 (the best case scenario), then we’d see 63% earnings growth in 2021.

2022 estimates have been moving in tandem with 2021 estimates thus far, and if that were to hold then 2022 earnings would be about $250.

Or to put another way, if stocks traded flat for the rest of the year the forward PE would be 17.1, at the high end of historical fair value

Historically, stocks very seldom grow into very high valuations, but rather see a return to fair value via a sharp correction.

But there was nothing normal about 2020 or this pandemic, and so it’s always possible that this epic rally might prove far more sustainable than pessimists believe.

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About author

Dividend Sensei

I'm an Army veteran and former energy dividend writer for The Motley Fool. I'm a proud co-founder of Wide Moat Research, Dividend Kings, and the Intelligent Dividend Investor. My work can be found on Seeking Alpha, Dividend Kings, iREIT, and the Intelligent Dividend Investor. My goal is to help all people learn how to harness the awesome power of dividend growth investing to achieve their financial dreams and enrich their lives. With 24 years of investing experience, I've learned what works and more importantly, what doesn't, when it comes to building long-term wealth and income streams and achieving long-term financial goals.

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