In a recent article for Financial Advisor magazine, Robert Shiller discusses whether today’s share prices are justified by the growth in reported earnings.
“With prices and earnings moving together on a nearly one-for-one basis,” Shiller writes, “one might conclude that the US stock market is behaving sensibly, simply reflecting the US economy’s growing strength.” But Shiller argues that earnings are volatile, adding that “sudden sharp increases tend to be reversed within a few years. This has happened dramatically more than a dozen times in the US stock market’s history.”
Earnings, he explains, are different from many other economic variables because “they are defined essentially as the difference between two series: revenues and expenses. Rapid growth in earnings for a few years can thus easily be followed by a return to the long-term trend or even subpar levels.”
Investors should know better than to overreact to earnings growth, Shiller says, “but they sometimes forget if popular narratives mislead.”
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