Stock Markets: Earnings per Share

This strategy exploits the influence on share prices of changing expectations for earnings growth, but is better shown in tabular form. (Use Tables > EPS Forecasts) Instead our charts for this strategy show both the historic relationship and our latest Top-Down Guess as to the future trend.
 
We have has developed an econometric model to forecast Earnings Per Share for entire markets from the top-down, in order to avoid traditional over-optimism generated by aggregating the bottom-up forecasts of investment analysts. (See Investor Education > Conceptual Framework > Investment Process > Forecasting Profits) For comparability, stock market indices have been rebased to set year-end 1994 at 100, and the EPS series has been rebased to set 1995 at 100.
 
In each chart the stock market index is shown as the thick white line on the right hand axis. The explanatory variable, our index of reported Earnings per Share, shown as the thin yellow line, uses the left hand axis as do our Top-Down Guesses for its future development, shown as the thin orange line.
 
Both historic data and Top-Down Guesses should be treated as only general indications of levels and trends. Because historic data on whole market Earnings per Share is seldom available, this series has been retrospectively reconstructed from a variety of sources of historic data. In order to achieve compatibility these have required considerable adjustments. Thus even the historic data should be considered as only estimates.
 
Top-Down Guesses suggest what would happen to future Earnings per Share based on our own econometric models. These utilise relationships established over up to three decades with key economic variables and project future Earnings Per Share based on Consensus Forecasts for those variables.
 
Given the enormous resources now devoted by the securities industry to forecasting corporate profits, the focus of attention has moved forward from current year profits in the early part of the period to next year's profits in the latter part of the period.
 
Please note that comparisons between countries are subject to differences in the reporting of corporate profits. In general Earnings Per Share may be over-stated where there is a tradition of profit maximisation and early adoption of full consolidation of subsidiaries, as in Anglo-Saxon countries, and under-stated where the interests of outside shareholders may take second place to tax minimisation. In recent years these differences have begun to diminish.
 
While it has not been possible to test this strategy historically owing the lack of past data on top-down EPS expectations, there is extensive literature from I/B/E/S and others about the effectiveness of changes in bottom-up EPS expectations in predicting individual stock prices.