Trading Techniques  |  JUL 1998

Predicting The Market With Earnings Per Share by Randall J. Covill

Predict The Market With Earnings Per Share by Randall J. Covill Take a look at the relationship between changes in earnings per share for each year and the performance of the market for the following year. Is there a correlation? One of Benjamin Graham's investment classics, The Intelligent Investor, has a chapter in which he discusses a comparison of the change in average stock earnings and the change in average stock prices. Intrigued, I decided to graph and calculate a linear correlation coefficient for the actual level in average stock earnings for the Standard & Poor's 500 versus the actual level in average stock prices for the S&P 500 in five-year intervals from 1930 to 1970, as reported by Graham. My results can be seen in Figure 1; the linear correlation coefficient is 92.78%. From this, I inferred that changes in average earnings per share over five years might be a good predictor of average changes in stock prices over the next five years.

by Randall J. Covill