Hi again!  This is Ben over at Boston Wealth maintaining my site, titled “Value of Perfect Information”.  When you hear the word earnings used by analysts, you need to understand the difference between the two types; “operating” and “as reported”.

When calculating the Price Earnings Ratio (P/E) for the S&P 500 or any stock for that matter, the E in the P/E is vulnerable to major manipulation because the accounting method used to derive the earnings can be misleading to say the least.  The S&P 500 P/E ratio reflects the performance expectations of the stock market.

Just remember this:

Bulls use “operating” earnings which are inevitably higher

Bears use “reported” earnings, and as such, are inevitably lower

Bulls use forward “operating” earnings for the next 12 months.

Bears use the past 12 months of earnings to make their case.  The advantage of that is obvious:  it avoids the dependence on estimates of earnings going forward.

The all important major difference?

Bulls use “operating” earnings which exclude write offs.

Bears use “reported” earnings which include write offs.  As such this is by far the gold standard or interpreting earnings because  these write offs that consist of miscellaneous non recurring one time charge and expenses typically take place almost every year.

The bulls use “operating” earnings which are also known as “pro forma” earnings

So the bears use “reported” earnings which is based on Generally Accepted Accounting Principles or “GAAP”

And this is how we get such a huge discrepancy between the bulls and the bears.

So let’s see where we are today.

Using a trailing four quarters of earnings ending June 30, 2009 for the S&P 500 at $7.51 and based on a closing price of 1066 for the S&P 500 yesterday, the S&P 500 P/E ratio is at an astonishing 141.94!

This is a very high P/E ratio because the trailing four quarters of earnings is so low.  By the end of this year S&P 500 trailing earnings are supposed it improve to $39.35 as the major write offs hopefully will not be a part of the four quarter trailing earnings.

So how does the future look assuming the  following parameters:  In the past seventy five years, we have had the stock market peaks topping out at about 20x reported (Ha! Now I know why you did the exercise above regarding “reported” earnings!)  earnings and the troughs took place at around 10x reported earnings.  The irrational exuberance period as coined by Greenspan had the P/E ratios well above 35 x reported earnings.

So this spreadsheet can help you drown out the CNBC noise and come up with your own “Value of Perfect Information” interpretation!