How A Major Bank "Calculated" That 20x P/E Is Now "Fair Value"

Tyler Durden's picture

Carbon-based traders of a certain vintage - which excludes today's 20-year-old hedge fund managers - may recall a time when a 15x P/E was considered "fair." Not any more. In fact, according to a new analysis by Barclays' equity strategist Keith Parker, which tries to factor in so-called "animal spirits" as a driver of valuation has found that 20x P/E is perfectly normal and fair for the current market, further demonstrating just how deep into the goalseeking rabbit hole US capital markets have fallen.

First, to prove we are not joking, here is Barclays explaining why it is important to quantify animal spirits as a input factor of "permanently high plateaued" P/E multiples:

Core drivers of the P/E multiple and animal spirit indicators


In order to estimate the effects of “animal spirits”, or the potential effects of some of President Trump’s agenda, we first model the S&P 500 P/E using the core fundamental drivers of equity valuations. We then compare the residual from the model (actual minus fitted P/E) to various indicators of “animal spirits” or potential policy changes, including: tax policy, credit spreads, inflation, macro volatility, long-term growth expectations and corporate/consumer sentiment data.


Rates, growth and payouts are the core drivers of the P/E. Using a dividend discount framework, an equity price is the present value of future dividends. Dividing both sides of the equation by earnings, the P/E multiple is equal to the dividend payout ratio divided by the cost of capital minus the growth rate. Accordingly, the US 10y yield, US real GDP yoy and the dividend payout ratio explain 57% of the movement in the S&P 500 trailing P/E multiple from 1955 to 1997. We use the 1955-97 sample period because confiscatory tax policies prior to 1955 distorted returns to equity holders (excess profit taxes, etc), and thus affected valuations, while the 1998-2001 tech bubble would also distort results.


Other “animal spirits” indicators also affect the P/E, even controlling for the core drivers. Including the US 10y, real GDP and dividend payout ratio variables in each regression, we assess the statistical significance of other variables as it relates to the S&P 500 P/E.

The punchline: "Based on our findings we incrementally add other variables to build a more comprehensive P/E model, to better evaluate the potential effects of “animal spirits” on equity valuations"

At this point Barclays provides numerous pages of tortured, goalseek "empirical evidence" to extract the result it is after. What it "finds" is that what was once a "fair" 15x P/E is now really 20x P/E thanks to, drumroll, animal spirits.

Post-election rally closed the valuation gap with the P/E now near “fair”. The current fitted S&P 500 trailing P/E of 19.6x reflects the historical average of 15.2x adjusted for lower rates (+3x), lower dividend taxes (+2x), slightly higher analyst long-term EPS growth (1.4x), lower macro vol (+0.5x), lower dividend payout ratios (-2.6x) and the net of credit spreads and growth (+0.3x). Accordingly, the current P/E of 19.4x, although high by historical standards, is far from pricing excessive optimism, based on our model.

Here is Barclays' rationalization:

It is difficult to discern how the fundamental drivers are impacting equity valuations using current values, let alone trying to assess the potential ramifications of policy changes. As a starting point, we lay out how the variables in our model are affecting the fitted P/E relative to the historical average (Figure 14).


By separating out the drivers of the multiple, we are then better able to assess how policy changes may impact each variable and thus the P/E. The historical average trailing P/E is 15x.

  • The US 10y yield at ~2.5% is much lower than the in sample average of 7%, which leads to a fitted P/E of 18x, all else equal.
  • Lower dividend taxes than the historical average adds another 2x.
  • Long-term EPS growth expectations using IBES data are now ~40bp above the historical average, which adds another 1.4x.
  • Earnings flat-lined since 2014 and EPS moved slightly below trend, which adds 0.5x to the trailing P/E.
  • Finally, inflation and IP volatility have been below historical averages, which adds another 0.5x.


On the negative side, dividend payout ratios are much lower than the historical average, which in turn reduces the fitted P/E by 2.6x. Real GDP growth is below average and is a 0.2x offset to the fitted P/E  value. Lastly, credit spreads are near the historical average.


Overall, the current fitted P/E is 19.6x based on the macro drivers of the multiple, compared to 19.4x for the actual P/E using broker adjusted earnings.

And here is Barclays' goalseeking exercise distilled to its undisputed visual glory:

And that, ladies and gentlemen is how sellside analysts use "animal spirits" to explain that a market which is valued 33% higher than historical average, is really "fairly valued."

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philipat's picture

Except that it isn't!! On a GAAP (As Reported) basis the Forward P/E is now 27X so the trailing P/E on a GAAP basis must be 35-40. SO lets' just agree that even on the basis of this BS goalseeked "analysis" the S&P is at least 50% overvalued and call it quits?

robertsgt40's picture

What happens when the "animal spirits" leave the zoo?

philipat's picture

A lot of local residents get very badly hurt. Except the Zoo Keepers who have locked themselves inside?

Lorca's Novena's picture

Ive heard rumors they start Hedge Funds that receive laundered money via former Secretery of States and their son in laws...

Giant Meteor's picture

My thought on this is, you are perhaps being a bit generous.

Over and out ..

weburke's picture

pe 100, happened in 2008, coming around again soon.

philipat's picture

I always try not to overstate my case or overdramatize things. But, yes....

Iconoclast's picture

50% overvalued is a decent shout.

Fizzy Head's picture

This has to be another Onion article, there is no way...... Animal spirits, LoL

Yen Cross's picture

  What a bunch of assclowns. I almost barfed up a lung when they said credit spreads were at historical norms.

hooligan2009's picture

simple questions, all other things being equal:

what is the growth in net earnigs on a GAAP and non-GAAP basis for the S&P500 assuming current effective tax rates and effective tax rates that are progressively 1% lower?

which S&P companies will report the biggest increases in net earnings on a GAAP and non-GAAP basis for each 1% drop in effective corporate tac rate?

clue: all the companies that engage in tax evasion SBUX, AMZN, Uber, GOOG, GS, C, PFE, GM, JNJ, F, FCAU will not see any increase in net earnings since they engage in tax fraud.

small and honest S&P500 businesses (high corporate tax rates) will see increses in net earnings of 3% per 1% corporate tax rate decrease - so a drop from 35% to 20% will see their net earnings increase by 45%

this is the potential, now watch an entrenched and fraudulent set of lobbyists claim this is not important.

slightlyskeptical's picture

earnings only increase by 23%.

100 X.35 = 35  100-35 = 65 profit

100 x .20 = 20 100-20 = 80 profit

15 increase in profit

15/65 = .23 or 23%  still not bad

So  a small cap stock trading at a 25 PE, say earnings of .65 = 16.25

company now earns .80 which equals a PE of just over 20

Tax cut would bring stocks back to just being a little overvalued. Better have a bunch of growth in there.

To play devils advocate you could say that the proper valuation of a biz is some % of net assets plus the cash flows the biz generates. On that basis the market is not all that overvalued. 

hooligan2009's picture

fair call... my goal seek malfunctioned

buzzsaw99's picture

Catherine: [Reading Robert's Notebook] "Let X equal the quantity of all quantities of X. Let X equal the cold. It is cold in December. The months of cold equal November through February. There are four months of cold, and four of heat, leaving four months of indeterminate temperature. In February it snows. In March the Lake is a lake of ice. In September the students come back and the bookstores are full. Let X equal the month of full bookstores. The number of books approaches infinity as the number of months of cold approaches four. I will never be as cold now as I will in the future. The future of cold is infinite. The future of heat is the future of cold. The bookstores are infinite and so are never full except in September..."


hooligan2009's picture

haha... and all errors are random but have a normal distribution (of snowflakes?)

buzzsaw99's picture

the sides per snowflake is constant but the number of snowflakes is increasing exponentially therefore the total number of sides is...

CRM114's picture

Whatever that nice woman from the Fed tells us it is?

Cassandra.Hermes's picture

It isn't Fed this time! It is the animal spirit of Trump believers, it is patriotic to give your money to the economy, common dude the whiner in chief has jobs to create!!

Bunga Bunga's picture

How the bank calculates it:
FairValue = avg(currentPE,SP500);

El Hosel's picture

What the fuck Wally?

You mean now that everybody knows the Markets are rigged to go up without corrections Fair value is only 25% higher?  This hardly seems "fair" at all.  All the "Investment Wankers" should stay home from work in protest, I will tell you when to go back to work.

Fair Value Out

Ajax_USB_Port_Repair_Service_'s picture

A P/E of 20 is normal and the U.S. unemployment rate is below 5%. Uh Huh.

CRM114's picture

I picture that scene from Apocalypse Now with the formation emerging from over the treeline , Wagner blaring out, only with flying pigs instead of Hueys ;)

SheHunter's picture

And that licensed pipeline welder of 30 years is working mornings at McDonalds and eves at Walmart because he wants to. 

werker's picture

Don't give a DAMNED about this garbage.  YOU ARE LYING AS ALWAYS!

KEEP IT UP WITH PAPER P.M's         REALLY enjoying being a stupid slave to EVIL MEN with

EVIL INTENT.   You have until 2/9/18 to rectify this corrupt fiat or else.  

Remember:    'Higher asset"?     I will END THIS ONCE AND FOR ALL.

             Hows oroville workin out?   Hows are the bridges?   Millions of tons of concrete,....LAID LOW

I have given you a repreive and jerry hides.   Time is short.

And never forget THE SPIRIT OF VIOLENCE that awaits the perpetrators.

My mercy is short,.... you were given a chance.  GOD is watching this.

WE ARE WAITING.      2/9/18

order66's picture

Well CAPE is an ass hair from 30 so there's that.........

JailBanksters's picture

The New Stock Values has nothing to do with the Company, the Sales or the Profits.

It's about how much somebody is prepared to pay for it, and that depends how much they can sell it for in the afternoon.

It's gone total Casino.


atomp's picture

It's not a fucking joke. It's called INFLATION.

Iconoclast's picture

It's the new abnormal. And all analysis has been rendered obsolete becuase when trump wakes up, farts, yawns, stretches, scratches his arse, fixes his slipped hair, shoves Melania out of bed to get his gold monogrammed slippers and he fires of his first tweet of the day, the markets react. Yes ladies and gents, we're now there, a complete shits and giggles clusterfukc.