Relying in part on data from the 19th century, Nobel Prize-winning economist Robert Shiller has been bearish for most of the 21st century. While his techniques survive academic scrutiny, the idea of the cyclically adjusted price-to-earnings (CAPE) ratio has failed investors for the past decade. The problem could be the data Shiller is using.
There are several ways to measure earnings. Earnings per share can be found on an "as reported" basis, which includes the impact of all accounting charges, or on an "operating" basis, which looks at how companies are performing before accountants get to work. Shiller prefers as reported earnings, while another widely respected economist, Jeremy Siegel, prefers a variation of operating earnings.
In the most recent quarter, AT&T (T) demonstrates the problem with as-reported earnings.
According to The Wall Street Journal, "The nonprofit Society of Actuaries recently updated its mortality tables for the first time since 2000 to reflect the longer lifespans, estimating today's retirees will live about two years longer than in 2000."
By one estimate, this change will require companies to report pension accounting charges of $140 billion that will reduce as-reported earnings but will have no impact on operating earnings.
In the case of AT&T, the charge is expected to be $7.9 billion, an amount that exceeds its reported earnings during the past twelve months.
Pension costs are real, but they are not paid immediately. The costs will be spread out over many years and could actually be more or less than estimated. Recognizing accounting charges like retirement benefits immediately distorts the earnings of a company.
Using operating earnings, the stock market is trading close to fair value. It is not more overvalued than it was in 2007, which could explain why Shiller reports that he is not avoiding the stock market. He is bearish as always but for the past decade, we've learned that when Shiller is bearish, investors should ignore his call.
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