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!

I would like to propose a solution to the multiple systemic problems now facing the United States. A solution so far, not discussed. Since this country de-pegged from gold in August of 1971, we have been on a long road to bankruptcy.The “dollar”, as the world’s reserve currency has been progressively abused by imprudent fiscal and monetary policy. The debt burden imposed by this on government from the national to the local level is intolerable and will never be repaid. The debt burden that the citizenry toils under is even more intolerable.

Solution: Declare ALL debt both public and private null and void. Complete the bankruptcy proceedings started nearly 38 long years ago.

What would this mean? It means that what ever real estate you now own and owe on is free and clear of debt. It means that your credit card balance drops to zero and your credit card is canceled. It means that your car loan is also canceled. It means that there is no longer any sovereign US debt.

Why not? The Chinese did that in 1949. The Russians have done it twice and Argentina does that every few years whether they need to or not. Means that no state government, county government or city government any longer has any debt. The downside: raises the question of moral hazard. Prudent individuals who did not take on debt would get no direct benefit. Also, lenders, both institutional and individual would be wiped out. But think of the upside, even for those prudent individuals who did not directly benefit from debt relief. Onerous tax burdens would be lifted.

As a bankrupt, we would be back to cash and carry. Only see upside from that. This country in a very short period of time, became the industrial engine of the world. A feat unsurpassed in history as this country became the envy of the planet. ALL done without ONE credit card or one HELOC.

Of course, there would be no money left as all “dollars” in existence (other than in coin collections!) are created out of debt. No real problem there, either. The US Mint holds in excess of 250,000,000 ounces of gold. That gold belongs to the people of this country, confiscated from them in 1933. This does NOT count any gold that may or may not belong to the people located in Ft. Knox (no audit there since President Eisenhower) or the gold “lent” to the Federal Reserve.

M Zero (currency and coin in circulation) and M1 (demand accounts) would be backed by said gold belonging to the people. To ensure on going monetary and fiscal discipline, said gold currency, issued by the US Treasury, would be freely redeemable in gold specie at the conversion rate established based on the amount of gold vs. M zero and M1. Then this country could get back to work creating REAL wealth which is the production of goods and services that people want and need.

Just an idea. What do you think?