Not exact matches
As we've demonstrated repeatedly, the valuation measures most strongly correlated with actual
subsequent returns, particularly over a 7 - 15 year horizon, are those that normalize for
profit margin variability in some way.
This adjustment has historically been important, as adjusting for that embedded
profit margin significantly improves the relationship between the CAPE and actual
subsequent market returns (something we can demonstrate both with algebraic return estimates and regression models — see
Margins, Multiples, and the Iron Law of Valuation).
Indeed, even Robert Shiller's cyclically - adjusted P / E (CAPE) is much better correlated with actual
subsequent market returns, across a century of market cycles, when we account for the
profit margin embedded in the 10 - year average of earnings.
The most reliable measures of individual stock valuation we've found are based on formal discounted cash flow considerations, but among publicly - available measures we've evaluated, price / revenue ratios are better correlated with actual
subsequent returns than price / earnings ratios (though normalized
profit margins and other factors are obviously necessary to make cross-sectional comparisons).
Recent cycles provide no evidence of deterioration in the relationship between reliable valuation measures (particularly those that aren't highly sensitive to fluctuations in
profit margins) and actual
subsequent market returns.
Indeed, adjusting for that embedded
profit margin boosts the correlation with
subsequent 10 - 12 year returns to nearly 90 %.
Though Wall Street's estimates of forward operating
margins imply soaring earnings in the next couple of years, it's useful to understand that in available data since the early 1980's, the higher Wall Street's expectations of
profit margins have been, the weaker the
subsequent performance of the S&P 500 has been over the following 3 - year horizon.
Finally, the chart below shows the interaction between the raw Shiller P / E and the embedded
profit margin in determining actual
subsequent market returns.
As I've detailed previously, when earnings - based measures are used to explain
subsequent market returns, the embedded
profit margin almost always carries as much impact as P / E itself.
For each level of
profit margins, the table shows the median P / E of the 500 largest stocks, their median annual return over the
subsequent 3 - year period, and their median return over the
subsequent 5 - year period.
Linux is dogged by many legal issues - and
subsequent licensing fees from Android hardware OEMs eat away at
profit margins.