A funny thing happens to an index's valuation when you choose not to entirely ignore the companies that have negative earnings (i.e. losses). Ever wondered what the P/E ratio of the Russell 2000 was given that it is full of companies where the 'E' is negative? The answer is simple – and ugly – as The Wall Street Journal exposes, the aggregate P/E of the Russell 2000 is over 200x which perhaps explains the gaping chasm between bond and equity valuations for this highly credit-sensitive cohort.
It seems very few 'investors' are willing to read or study reality anymore…
If you go to the “fact sheet” for the Russell 2000 index trying to find the standard PE valuation metric, the only one provided by the index keepers is something called “P/E Ex-Neg Earnings.” The current valuation offered is 19.8, which sounds much more reasonable than the latest raw PE estimate from The Wall Street Journal): 295.81…
That can't be right, right? My friendly asset-gatherer would have warned me.. or CNBC's best and brightest would have raised red flags?
It appears not… So here are 3 charts to show him/them next time they try to pile you into this underperforming index.
As the 'dreaming' divergence between GAAP and non-GAAP (as we noted yesterday) widens ever more and the gap between Small cap earnings (inclusive and exclusive of 'losses' and extraordinary items) explodes…
(in simpler terms, green is the index's earnings when you ignore the companies that have negative earnings; red is inclusive of all companies and aggregating losers and winners – which would you prefer to judge the index's valuation?)
Which explains the surging reality of Russell 2000 P/E valuations…
As Alhambra's Jeffrey Snider previously noted, if more and more small companies have started losing money, which the difference between the current real/raw PE and that figure Russell itself provides more than suggests, there are more than a few implications here.
Which explains why Russell 2000 index remains suspended (on a string of faith and momentum) above the ugly reality that credit markets are prophesying…
And given that small cap firms are the most-sensitive to credit market access, this is likely to continue as credit market conditions tighten (even absent The Fed)…
h/t Randy W
via Zero Hedge http://ift.tt/1QeFhlU Tyler Durden