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When Earnings Mean Nothing

One of the things Jim's mentioned on air a lot lately that we haven't devoted an entire segment to is the unreliability of price-to-earnings multiples for valuing stocks in this environment.

The upshot here is that in many sectors you can't really use a stock's multiple to judge its cheapness. The reason: The earnings estimates for the vast majority of companies that are economically sensitive are way too high. We don't know what the earnings will ultimately be, but we're pretty sure they'll be less than what the Street is expecting because we've yet to see a wave of major estimate cuts.

Traditionally, the multiple is the first thing you'd look at when you're trying to figure out if a stock is cheap or expensive. But that falls apart when the earnings are an unknown quantity. You've heard Jim say the formula on air, maybe seen him hold up the flash cards, too: E x M = P, earnings per share times the multiple equals the price. In this environment, even if you think you know what multiple a more cyclical stock deserves, you can't put a price on it because we don't know how bad the earnings will be, but we do expect them to be bad.

That's why with companies from steel maker Nucor to diaper and tissue maker Kimberly-Clark, Jim's used not the multiple but the dividend yield to judge the stock's relative cheapness. We've been talking a lot lately about stocks that formerly weren't high yielders but because of the big declines now have great dividends because those are reliable indicators of value, in addition to being money in your pocket.

If you were wondering why Jim spent so much time Friday focusing on the dividends of the three stocks he highlighted, United Technologies, Merck, and Watsco that's the reason. If you were puzzled about why we've pretty much stopped talking about price to earnings multiples entirely when discussing stocks, now you know: Until we get through this mess, a stock's price-to-earnings multiple on dubious earnings just doesn't tell you very much.










Cliff Mason is the Senior Writer of CNBC's Mad Money w/Jim Cramer, and has been that program's primary writer, in cooperation with and under the supervision of Jim Cramer, since he began at CNBC as an intern during the summer of 2005. Mason was the author of a column at TheStreet.com during 2007, which he describes as "hilarious, if short-lived." He graduated from Harvard College in 2007. It was at Harvard that Mason learned to multi-task, mastering the art of seeming to pay attention to professors while writing scripts for Mad Money. Mason has co-written two books with Jim Cramer: Jim Cramer's Mad Money: Watch TV, Get Richand Stay Mad For Life: Get Rich, Stay Rich (Make Your Kids Even Richer). He is 100% responsible for any parts of either book that you did not like.

Mason has also had a fruitful relationship with Jim Cramer as his nephew for the last 23 years and will hopefully continue to hold that position for many more as long as he doesn't do anything to get himself kicked out of the family.




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