John Hussman: Revenues Are A Better Sufficient Statistic Than Year-To-Year Earnings

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In his latest article titled – Top Dollar For Top Dollar, John Hussman explains why revenues are a better sufficient statistic than year-to-year earnings. Here’s an excerpt from the article:

We’ll begin with an observation, followed by a broad range of historical evidence to demonstrate it. Across decades of market cycles, particularly at market extremes, I’ve emphasized that stocks are not a claim on a single year of income, but are instead a claim on a very long-term stream of future cash flows that will be delivered to investors over time.

Using a single year of results as a metric is only appropriate if that single year of results can be considered a “sufficient statistic” that’s representative of the entire future stream.

“A valuation multiple is nothing but shorthand for a proper discounted cash flow analysis. One can only reliably use a ‘price/X’ multiple to value stocks if ‘X’ is a sufficient statistic for the very long-term stream of cash flows that stocks are likely to deliver into the hands of investors for decades to come.

Not just next year, not just 10 years from now, but as long as the security is likely to exist. Now, X doesn’t have to be equal to those long-term cash flows – only proportional to them over time (every constant-growth rate valuation model relies on that quality).

If X is a sufficient statistic for the stream of future cash flows, then the price/X ratio becomes informative about future returns. A good way to test a valuation measure is to check whether variations in the price/X multiple are closely related to actual subsequent returns.

The truth is that in the valuation of broad equity market indices, and in the estimation of probable future returns from those indices, revenues are a better sufficient statistic than year-to-year earnings (whether trailing, forward, or cyclically-adjusted).

Don’t misunderstand – what ultimately drives the value of stocks is the stream of cash that is actually delivered into the hands of investors over time, and that requires earnings. It’s just that profit margins are so variable over the economic cycle that year-to-year earnings, however defined, are flawed sufficient statistics of the long-term stream of cash flows that determine the value of the stock market at the index level.”

You can read the entire article here:

John Hussman – Top Dollar For Top Dollar

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