Tuesday, January 25, 2005

Earnings Reliability and Total Returns (II)

Does higher earnings reliability lead to higher returns? For evidence to begin to answer this question, I went back to the Dow earnings data and generated a scatter plot against total returns over the same period of time, 1995-2004. Unfortunately, I don't know how to upload graphs to this blog; so, a simple numerical table will have to suffice:

Tables show:
Dow component: Earnings reliability vs. total return (annual)

Companies with HIGHEST earnings reliability:
Home Depot (HD): 2.39 vs. 18%
General Electric (GE): 2.38 vs. 17%
Wal-Mart (WMT): 2.23 vs. 21%

Companies with LOWEST earnings reliability:
Boeing (BA): -0.27 vs. 4%
Honeywell (HON): -0.31 vs. 6%
Hewlett-Packard (HPQ): -0.47 vs. 8%

Among the remaining 24 Dow components:

Companies with HIGHEST total returns:
Citigroup (C): 0.70 vs. 23%
United Technol. (UTX): 0.53 vs. 22%
Microsoft (MSFT): 0.76 vs. 20%

Companies with LOWEST total returns:
General Motors (GM): 0.23 vs. 3%
Coca-Cola (KO): 0.28 vs. 3%
Merck (MRK): 1.11 vs. 3%


1. Companies with the highest earnings reliability (HD, GE, WMT) produced among the highest total returns (average = 19%) over the past 10 years. By comparison, companies with the lowest earnings reliability (BA, HON, HPQ) had considerably lower total returns (average = 6%);

2. The remaining 24 companies, which sit in the central "cloud" of the scatter plot, also show the same correlation: Companies with the highest returns (C, UTX, MSFT) had, on average, higher earnings reliability than companies with the lowest returns (GM, KO, MRK).

The full scatter plot of all 30 Dow components has an r-squared coefficient of 0.24, giving us some confidence that, as expected, higher earnings reliability is generally correlated with higher total returns.

Conclusion: To the extent that companies with consistent earnings in the past continue to post consistent earnings in the future, we should give serious consideration to companies with high earnings reliability as we search for higher returns.


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10:18 AM, October 24, 2011  

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