A Closer Look at Earnings

When evaluating stocks based on price-to-earnings (or P/E), the question quickly arises: Which “E” are we using? There’s usually a big difference between P/Es based on trailing 12-month earnings, and those based on anticipated earnings in the year ahead. When the gap between these two figures is wide, some market observers question whether analysts are being overly optimistic in their forward earnings estimates. That sets investors up for disappointment if companies fall short.

To get a sense of whether forward estimates currently in place for the S&P 500 may be excessive—particularly in light of an economic recovery that has at times moved in fits and starts—we took a look at how earnings have historically related to weekly jobless claims figures. We believe the latter is a good proxy for the economy’s direction, as an improvement (decline) in this figure suggests companies have firm grounding for their positive outlook.

The results of this research told a fairly consistent story: a positive trend in employment, as indicated by declining weekly claims figures, has preceded significant improvement in earnings on S&P 500 stocks.

Weekly Jobless Claims vs. S&P 500 Earnings

Source: Bloomberg, Inc., 7/15/1994 to 8/30/2013

Because the weekly jobless claims figure can be volatile from week to week, we employ a 50-day rolling average to better capture the longer-term trend behind the number.

The current state of affairs, with weekly claims in a steep decline, suggests to us that there is support for further expansion of corporate earnings. While this is clearly not a definitive predictor of future performance, we believe it merits further consideration as investors ponder the direction of both the markets and the economy.

Ted Baszler, CFA, CPA, is Vice President and Portfolio Manager for the Select Value Fund. He is also Portfolio Manager for three separately managed account strategies: Opportunistic Value Equity, Mid Cap Value, and Core Plus. He has 22 years of industry experience, 19 at Heartland.

Past performance does not guarantee future results.

Economic predictions are based on estimates and are subject to change.

The price-to-earnings ratio (forward) of a stock is calculated by dividing its current per-share price by its per-share estimated earnings for the next four quarters. The price-to-earnings ratio (trailing) of a stock is calculated by dividing its current per-share price by its per-share earnings from the last four quarters. The S&P 500 Index is a widely used U.S. equity benchmark. It contains 500 U.S. stocks chosen for market size, liquidity, and industry group representation.

CFA is a trademark owned by CFA Institute.

The Heartland Funds are distributed by ALPS Distributors, Inc., and Ted Baszler is a Registered Representative of ALPS Distributors, Inc.

Separately managed accounts and related investment advisory services are provided by Heartland Advisors, a federally registered investment adviser. ALPS Distributors, Inc., is not affiliated with Heartland Advisors.

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