Wall Street keeps playing the same game: pie-in-sky earnings estimates far in the future that it whittles down as the future approaches. When the future arrives, the estimates are “beatable” and are consequently beaten by the subject companies, which then see their stocks rally. It goes on every quarter, but it’s getting harder and harder because earnings are shrinking, in some cases into losses. From Wolf Richter at wolfstreet.com:
It was a historic day. Google’s market capitalization jumped by over $60 billion, enough to bail out Greece for a couple of years, and handily beating the prior single-day record of $46 billion held by Apple.
The thrilling event occurred on the news that Google’s second-quarter revenues rose 11% year-over-year – which seems like a lot in a quarter when S&P 500 revenues are expected to shrink – and “net profit” rose 17%, while net earnings per share of its class A common stock inched up a measly 1%, which sent these shares up 16%.
Or maybe it was on the news that Google finally hadn’t disappointed analysts’ expectations. Or rather, that they’d finally lowered their expectations enough to where Google could exceed them.
The action gave the NASDAQ a big push to rise almost 1% to another all-time record. It’s now 4% above the prior crazy record of March 2000. And this time, everyone agrees, it’s different.
But at least, Google had a profit. A big one, $3.9 billion, so “earnings” with a plus-sign in front of it, rather than a negative-sign. A feat that seems impossible to reach for a number of other companies in the tech space where profits are optional. Or perhaps even a handicap.
Morgan Stanley’s “New Tech” index is trading at 149.5 times forward earnings, Barbara Kollmeyer at MarketWatch pointed out. And that’s high. But it’s based on pro-forma, ex-bad items estimates of what earnings might possibly look like in the next twelve months under the most optimistic or simply fabricated circumstances. So rose-colored fiction.
As those quarters get closer, analysts whittle their earnings estimates down. By the beginning of the reporting period, they’re then close to something that these companies can actually beat. Even better, those “earnings” to beat might actually be with a minus sign in front. Just lose less money than expected. That formula works all the time.
So “New Tech” is very expensive. And compared to the peak of the last tech bubble which blew up in March 2000?
“This is probably bubblier than it was then given the lack of market memory,” Keith McCullough, CEO of Hedgeye Risk Management, told Kollmeyer.
Looking at past performance, the “New Tech” index sports an average trailing twelve-month P/E ratio of 69. And it’s high. But it obscures reality.
The P/E ratio of a company that has a loss is undefined. It’s usually expressed as “N/A” or just a dash. It’s thus excluded from the average P/E ratio of the index (table). Hence, only profitable companies are included in the calculation of the P/E multiples of the overall index. Which gives the “earnings” part of the P/E ratio a strong upward bias.
