S&P gets its earnings wrong
Today’s Op-ed makes an interesting case for changing how S&P computes “E” in P/E for the S&P 500 index.
http://online.wsj.com/article/SB123552586347065675.html
Standard & Poor’s recently shocked investors with an announcement that reported earnings for its S&P 500 Index for the fourth quarter of 2008 are forecast to be negative for the first time since such data were calculated in 1936.
… Suppose on a given day the only price changes in the S&P 500 are that the largest stock, Exxon-Mobil, rose 10% in price and the smallest stock, Jones Apparel Group, fell 10%. Would S&P report that the S&P 500 was unchanged that day? Of course not. Exxon-Mobil has a market weight of over 5% in the S&P 500, while the weight of Jones Apparel is less than .04%, so that the return on Exxon-Mobil is weighted 1,381 times the return on Jones Apparel. In fact, a 10% rise in Exxon-Mobil’s price would boost the S&P 500 by 4.64 index points, while the same fall in Jones Apparel would have no impact since the change is far less than the one-hundredth of one point to which the index is routinely rounded.
Yet when S&P calculates earnings, these market weights are ignored. If, for example, Exxon-Mobil earned $10 billion while Jones Apparel lost $10 billion, S&P would simply add these earnings together to compute the aggregate earnings of its index, ignoring the vast discrepancy in the relative weights on these firms. Although the average investor holds 1,381 times as much stock in Exxon-Mobil as in Jones Apparel, S&P would say that that portfolio has no earnings and hence an “infinite” P/E ratio. These incorrect calculations are producing an extraordinarily low reported level of earnings, high P/E ratios, and the reported fourth-quarter “loss.”
