What if Multiples Hadn’t Expanded in 2013?

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Last year the S&P 500 rose by 30% while earnings grew by 5.5%.  This year analysts expect earnings to grow by another 10%, meaning that they expect earnings to grow by 15.5% from 2012 through 2014.

The red line below tracks the price of the S&P 500 if it grew at a constant rate equal to the earnings growth rate between the end of 2012 and 2014.  For the S&P to match the earnings growth path today, it would need to decline by about 14%, to 1544.   By the end of the year, the index would finish at 1650, around 11% lower than it started the year.

The line effectively represents the line at which the S&P 500 trades at the same earnings multiple as it did at the end of 2012.  The multiple back then was 13.7x trailing earnings, which isn’t really that cheap or expensive.

Price Growth Equals Earnings Growth