Earnings season raises questions about valuations

NEW YORK - Earnings season is living up to its reputation as a time of angst on Wall Street, with investors already having bailed on Intel's revenue outlook. Those who were quick to sell worried that business conditions, particularly in the high-tech industry, don't justify stock prices after seven weeks of gains. With an overall 22 percent profit rise predicted for the Standard & Poor's 500, there is great anticipation about fourth-quarter earnings. Some analysts are advising caution, however, saying stock prices may already reflect the expected gains. "On a short-term basis, the market is probably a little stretched, and vulnerable to disappointment," said Richard A. Dickson, senior market strategist with Lowry's Research Reports in Palm Beach, Fla. "Obviously, positive surprises could motivate buyers, but unless it's a major surprise it would be difficult for stocks to make headway." While the markets lurched midweek after Intel Corp. offered a tepid outlook for the next quarter, positive results from other high-tech bellwethers, such as IBM Corp., Yahoo! Inc. and Apple Computer Inc., stopped the selling from accelerating. "The market showed pretty good resiliency to the news from Intel," said Brian Williamson, an equity trader at The Boston Company Asset Management. "I got a little worried, but them we saw some really good news from IBM and other tech stocks, and you know what? The market looks OK." News about the proposed $58 billion merger of J.P. Morgan Chase & Co. and Bank One Corp. also gave the market a boost. As long as positives continue to outweigh the negatives, Williamson said he thinks the buying momentum is likely to continue. Trading volume is up, a signal that institutional investors are making big moves. Still, there are worries that what's really driving the market is speculation. The Nasdaq composite index has surged 6.5 percent since the beginning of January, which has some wondering whether tech stocks have gone too far too fast. "Right now the risk is very high because valuations are very high," said Brett Gallagher, head of U.S. equities at Julius Baer investment management. "If you look at P/E and other simple measures ... we're anywhere from 20 percent overvalued, on up." The price-to-earnings ratio, or P/E, shows the relationship between the current price of a company's shares and its earnings over the last 12 months. For example, if a company trading at $10 earned $1 per share last year, its P/E ratio is 10. This multiple tends to be higher when interest rates and inflation are low. Historically, the average P/E ratio of companies in the S&P has been about 17.4, but the current P/E stands at 28. By Gallagher's reckoning, that means the market would have to fall more than 30 percent to get back to the historical averages. But buyers don't seem to be discouraged about stocks being overpriced. It may be old news to them by now: Valuations were high in terms of P/E throughout 2003. "Valuations ... are in the eye of the beholder," Dickson said. "It certainly hasn't kept people from being buyers. Given the current investor psychology, I wouldn't say valuations are an issue." The biggest surprise this year, Dickson said, could be tech stocks continuing their market leadership. For the week, the Dow Jones industrial average was up 141.62, or 1.4 percent, at 10,600.51. The Nasdaq gained 53.54, or 2.6 percent, to close the week at 2,140.46. The S&P 500 rose 17.97, or 1.6 percent, to 1,139.83. The Russell 2000 index of smaller companies rose 15.21, or 2.6 percent during the week, to 590.41. The Wilshire 5000 Total Market Index - a capitalization-weighted index that measures more than 5,200 U.S. based companies- ended the week at 11,116.04, up 187.04 percent from last week. A year ago the index was 8,530.32.