Monday, May 9, 2022

You may have noticed that the stock market has been going down the tubes lately. Here at Calcbench, however, we wanted to press further. Just how far down the tubes have share prices gone, really?

To answer that question, an analyst could look at the price-to-earnings (P/E) multiple for one or more firms you follow — but that might not be the most accurate metric, because the earnings part of the equation is net income. Since scads of companies adjust net income and report non-GAAP earnings, that implies that they don’t believe “pure” net income is the most accurate measure of business performance. That, in turn, calls into question whether P/E ratios based on net income are the most reliable metric of value.

We decided to answer the question by examining the trailing 12 months of net income for 353 non-financial firms in the S&P 500, and then adding back the amortization of intangible assets to net income. Why? Because those amortization costs are the most common non-GAAP adjustment that large firms make. If companies believe that amortization costs are worth adjusting for net income, then by the same logic those costs are also worth adjusting for P/E ratios.

Once we had those adjusted earnings numbers, we then divided them into companies’ market capitalization at the end of March and at the close of business on May 5. Table 1, below, shows the results for all 353 firms we studied, tallied up as a whole.

As you can see, including the amortization adjustment produces a small but significant difference. We also calculated the earnings yield, which essentially is the inverse of the P/E ratio. It looks backwards at prior earnings, rather than anticipates future earnings; and earnings yield rises as share price falls. Again, we see a small but significant difference when amortization adjustments are included in the calculations.

What to Do Next

For the record, the long-term historical average P/E ratio for S&P 500 firms falls somewhere between 13 and 15, according to Investopedia, which suggests that the market still has a few more tubes to go down before it reaches bottom. We also found a nifty chart from Macrotrends.com that tracks P/E averages back to 1926 if you’re that much of a history buff.

In more practical terms, you could also use insights like this to sharpen your own assessments of firms’ value. For example, you could compare the adjusted P/E of firms you follow against our adjusted group averages; or you could research adjusted P/E averages of specific sample groups — say, all tech stocks. You could even add other adjustments if you like, such as for stock-based compensation.

One would do all these calculations from our Multi-Company page. There, you can select the companies you want to study and start by finding their net income. Then you can add other non-GAAP adjustments by entering them into the search field on the left-side of your screen above the company results. Calcbench tracks all the most common non-GAAP adjustments, so you can pull them up with a few keystrokes.

That gives you all the data you need to start adjusting earnings, then adjusting P/E ratios, and then estimating whether a firm’s share price still has further down the tubes to go or whether it’s time to buy.


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