Rising Profits Make Stocks Look Cheap

Although the market wobbled over worries about Greek debt, stock prices have been rising fast—and corporate profits have risen even faster. As a result, even after the biggest rally since the 1930s, U.S. stocks seem far from overpriced.

Analysts lifted their forecasts for profits in the year ahead for all sorts of companies, from consumer electronics maker Apple (AAPL) to railroad operator CSX (CSX), by 10 percent on average in April, the largest monthly increase since at least 2006. The Standard & Poor's 500-stock index is trading at 13.5 times forecasts for earnings during the next four quarters, a level many analysts find attractive.

Big investors such as BlackRock (BLK) are snapping up companies whose results are most tied to economic expansion. "The stock market is incredibly inexpensive," says Kevin Rendino, who manages $11 billion for BlackRock, the world's largest asset manager. "I don't know how the bears can argue against how well corporations are doing."

Analysts expect S&P 500 companies to earn $86.89 a share in the next year, according to Bloomberg data. And they've been boosting their profit projections, in part because so many companies are beating estimates now. More than 77 percent of the 381 companies in the S&P 500 that reported first-quarter results by May 4 have topped estimates, Bloomberg data show.

There are other ways to look at the numbers. David Rosenberg, chief economist of money management firm Gluskin Sheff + Associates, says U.S. stocks are poised for losses because they've become too expensive. Using average annual earnings over the past 10 years—the method favored by Yale professor Robert J. Shiller, the price-earnings ratio of the S&P 500 was 22 on Apr. 30, the highest end-of-month figure since June 2008, and well above the long-term average of 16.4.

Economic growth will slow and stocks retreat as governments around the world reduce spending after supporting their economies through the worst recession since the 1930s, says Komal Sri-Kumar, chief global strategist at TCW Group (TSI). "The correction is going to come," Sri-Kumar said in an interview with Bloomberg Television on Apr. 21. "You now have a debt bubble growing on the sovereign side, and we're slow to recognize how negative that could be."

For now, though, corporate profits are pushing stocks higher. "The earnings story is very supportive of the market even after the rally over the last year," says Liz Ann Sonders, chief investment strategist at Charles Schwab (SCHW). "The recovery is real, it's V-shaped, and it's got legs."

The bottom line: If corporations keep piling up profits as rapidly as analysts expect, the stock market rally has a long time left to run.

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