Can I “read ” market expectations using earnings per share (EPS) or price-to-earnings (P/E) multiples?
The answer is an emphatic “No”! Investors who use EPS and P/E multiples may have their hearts in the right place, but their money on the wrong idea. Granted, the investment community undeniably fixates on EPS. Business publications amply cover quarterly earnings, EPS growth, and price-earnings multiples. This broad dissemination and the frequent market reactions to earnings announcements might lead some to believe that reported earnings strongly influence, if not totally determine stock prices. Extensive empirical research finds that the market sets the prices of stocks just as it does any other financial asset. Specifically, the studies show two relationships. First, market prices respond to changes in a companys cash-flow prospects. Second, market prices reflect long-term cashflow prospects. Static measures such as reported EPS or estimates of next years EPS do not capture future performance, and ultimately they let investors downespecially in a global economy marked by spirited comp
