This means that forward earnings, built on a foundation of recent operating earnings, will tacitly assume no future drag from the inevitable extraordinary items that overwhelmingly tend to be negative.Īs a result, estimates of individual companies’ future reported earnings-when aggregated across the full market-will reliably overstate aggregate future market earnings and understate the aggregate market P/E ratio. They cannot know, however, which companies may do so in any given year. In practice, companies choose to exclude far more negative extraordinary items than positive, which has led some analysts to whimsically describe operating earnings as “earnings before whatever went wrong.” Analysts know that every year some companies will disclose truly awful losses, depressing those companies’ reported earnings. These assumptions introduce a large bias into aggregate market earnings, hence, into aggregate market P/E ratios. Many analysts will therefore analyze a stock’s price-to-earnings (P/E) ratio, or the P/E for the aggregate market, using forward earnings for the next quarter or next year, which are built on a foundation of recent past operating earnings. Operating earnings should measure earnings from ongoing operations, excluding nonrecurring extraordinary items and discontinued lines-whether positive or negative-that will not be part of future earnings.Market prices of stocks are based on discounted future earnings, not past reported earnings. ![]() ![]() Forecasts of future operating earnings for the market aggregates begin with two sensible assumptions:
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