Blog - Investing Notes

December 28, 2007 - Update: A Long-Run View of Operating Earnings

How do aggregate corporate operating earnings behave over the long run? Does the earnings growth rate predictably revert to some mean value? Using actual and estimated S&P 500 earnings data from Standard and Poor’s for 1990-2008, we find that:

The following chart shows the 12-month trailing operating earnings by quarter for the S&P 500 for 1990-2008, with current estimates for the fourth quarter of 2007 and all of 2008. For comparison, it also shows a best-fit exponential curve for the actual earnings history. The formula for the best-fit exponential indicates a quarter-over-quarter (annual) compound growth rate of about 2% (6.2%) for 1990-2007. Visual inspection suggests reversion to this compound growth rate. However, if there is a predictable cycle above and below a long-run growth rate, this sample is not long enough to infer cycle period and amplitude reliably.

For another perspective on earnings growth reversion, we examine the explicit earnings growth rate.

The next chart compares the nominal and real (inflation-adjusted) year-over-year S&P 500 operating earnings growth by quarter from the first quarter of 1990 through the third quarter of 2007. We calculate real earnings growth by subtracting the contemporaneous, non-seasonally adjusted 12-month trailing inflation rate from the year-over-year earnings growth rate for each quarter. The arithmetic mean growth rates, indicated by dashed lines, are 8.9% and 6.0% for the nominal and real data, respectively. Again, visual inspection suggests reversion to the mean, but the sample is not long enough to infer cycle characteristics (if there are any.)

In summary, 18 years of evidence supports some belief in the reversion of the aggregate operating earnings growth rate to a mean, but it does not support a belief that investors can time the reversion.

For analysis of the relationship between aggregate operating earnings and the stock market, see the Reversion-to-Value Model. For a close-up on operating earnings, see Earnings Trends. For formal research on earnings growth rate reversion, see our blog entry of 1/12/06