Earnings, Stock Prices, and the Voting Machine

“The stock market is a voting machine rather than a weighing machine. It responds to factual data not directly, but only as they affect the decisions of buyers and sellers.”- Graham and Dodd, Security Analysis

Earnings drive stock prices – so says investing lore. As earnings rise or fall, stock prices move higher or lower by a commensurate amount.

Is this actually how it works?

At first blush, it certainly seems so. In looking at a simple chart, earnings and stock prices appear to move closely together.

S&P 500 Index and TTM Operating EPS from 1988 to 2017 image

Data Source: YCharts. Date Range: 1988 – 2017.

But appearances can be deceiving. While earnings and stock prices tend to move together over long periods of time, in the short run there can be wide divergences.

In any given year, predicting the change in the S&P 500 based on the change in earnings is a difficult game to play. There have been years in which earnings have declined but stocks finished higher (1991 and 2007) and years in which earnings have increased but stocks finished lower (1994, 2000, 2002 and 2011).

In most years (79% of the time since 1989), earnings and stock prices move in the same direction, but the magnitude is far from equivalent. For example, in 1998 earnings rose 0.6% while stock prices advanced 26.7%. In 2001, earnings declined 30.8% while stock prices declined only 13.0%.

Changes in earnings vs Changes in stock prices of S&P 500 from 1989 to 2017

Data Source: YCharts. Note: S&P 500 returns in this table are based on index price levels, not total return including dividends. EPS = Earnings Per Share. 

What is the source of these discrepancies?

Changes in investor sentiment, what Graham and Dodd called the “voting machine.” This change in sentiment leads to expansion or contraction in multiples (ex: P/E ratio) that oftentimes supersedes changes in earnings.

1991 is perhaps the best example of this phenomenon when earnings fell 14.8% while stock prices rose 26.3%. The result: a multiple expansion of over 48%, moving the P/E ratio on the S&P 500 from 14.6 to 21.6.

Image of expansion of P/E ratio on the S&P 500 from 1989 to 2017

Data Source: YCharts. Note: S&P 500 returns in this table are based on index price levels, not total return including dividends. P/E = Price to Earnings Ratio.

When changes in prices exceed changes in earnings, multiples expand. When changes in earnings exceed changes in prices, multiples contract.

Over the past six years (2012 – 2017), multiples have expanded every year as gains in the S&P 500 have outpaced gains in earnings.

Will multiples expand again in 2018?

As we have seen, the answer to that question will depend not only on changes in earnings but also changes in sentiment.

According to S&P Dow Jones, operating earnings are expected to increase 24.8% in 2018, (moving from $125 to $156), the largest increase since 2010.

If these expectations are met and the S&P 500 finishes end the year higher by 24.8%, the P/E multiple will remain unchanged at 21.4.

Image of S&P 500 level vs P/E ratio

Data Source: YCharts. Note: These are hypothetical assumptions for year-end 2018.

While it’s possible that happens, it should by no means be expected. In 62% of years since 1989, there has been more than a 10% change in the P/E multiple.

Image of P/E changes from 1989 to 2017

Data Source: YCharts.

Why would multiples expand or contract this year? Any number of reasons: changes in future earnings expectations, economic conditions, central bank policy, interest rates, inflation, geopolitics, etc.

Basically, anything that influences investor sentiment can have an impact on the multiple investors choose to pay today for a given level of earnings. Needless to say, predicting investor sentiment is a difficult game, which in turn makes predicting future stock prices exceedingly difficult. Further complicating matters is the fact that predicting future earnings is not any easier.

The good news is that you don’t have to predict such things to reap the benefits of being invested in a diversified portfolio over time. In fact, predicting often does more harm than good as it can lead to taking unwarranted and deleterious actions in your portfolio. The next time someone asks you where you think stocks, earnings and multiples are going, don’t be afraid to say “I don’t know.”


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Charlie Bilello is the Director of Research at Pension Partners, LLC, an investment advisor that manages mutual funds and separate accounts. He is the co-author of four award-winning research papers on market anomalies and investing. Mr. Bilello is responsible for strategy development, investment research and communicating the firm’s investment themes and portfolio positioning to clients. Prior to joining Pension Partners, he was the Managing Member of Momentum Global Advisors and previously held positions as a Credit, Equity and Hedge Fund Analyst at billion dollar alternative investment firms.

Mr. Bilello holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. Charlie holds a J.D. and M.B.A. in Finance and Accounting from Fordham University and a B.A. in Economics from Binghamton University. He is a Chartered Market Technician (CMT) and also holds the Certified Public Accountant (CPA) certificate.

In 2017, Charlie was named the StockTwits Person of the Year. He is a frequent contributor to Yahoo Finance and has been interviewed on CNBC, Bloomberg, and Fox Business.

You can follow Charlie on twitter here.


Pension Partners, LLC is a federally registered investment adviser under the Investment Advisers Act of 1940. Registration as an investment adviser does not imply a certain level of skill or training. The oral and written communications of an adviser provide you with information about which you determine to hire or retain an adviser. For more information about Pension Partners please visit: and search for our firm name.

The information herein was obtained from various sources. Pension Partners does not guarantee the accuracy or completeness of such information provided by third parties. The information given is as of the date indicated and believed to be reliable. Pension Partners assumes no obligation to update this information or to advise on further developments relating to it.

Past performance is not indicative nor a guarantee of future results.


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The Standard & Poor’s 500, often abbreviated as the S&P 500, or just the S&P, is an American stock market index based on the market capitalizations of 500 large companies having common stock listed on the NYSE or NASDAQ.

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