Using Forward Earnings

We have noted the poor fit — both descriptive and prescriptive — of using backward-looking earnings as a valuation measure.  Let’s consider a look at forward earnings.  The chart here shows Thomson First Call forward earnings versus the yield on the ten-year Treasury note.  It is a simple method, testing the idea that investors look at long-term returns from risk-free bonds and compare those to the earnings yield of stocks.  There is a debate about the risk of stocks versus bonds.  There is a debate about which interest rate measure is the best comparison.

Taking this as a starting point, we wish to evaluate the concept of making SOME comparison in asset types.  The choice of the best interest rate and special circumstances is relevant, and will be the basis of further discussion.  For the moment, look at this chart and see whether it has more appeal than the poor-fitting backward approach.

Fed_model The chart begins with the very first date at which forward earnings were available.  It was named the Fed Model by Dr. Ed Yardeni, not because the Fed endorsed it in some way, but because it was developed in some internal papers.
The series stops before the "bubble era."

Does it look useful?  The next step is to see what it tells us about the later time periods.

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