A new profit series approximates total national after-tax earnings on a financial accounting basis as reported by U.S. stockholder-owned corporations. The new series, called “stockholder earnings,” uses the National Income and Product Accounts (NIPA) corporate profit measures as its base, but subtracts the profits of quasi-governmental entities, such as the Federal Reserve banks, and includes certain items that are excluded from NIPA profits, such as capital gains and dividends received from other companies.

Stockholder earnings is in turn used to derive several new series, including a cash flow series for U.S. corporations and two versions of inflation-adjusted stockholder earnings. The first of these adds to stockholder earnings deferred taxes and makes two adjustments for the effects of inflation to convert depreciation and inventory changes to a current cost basis. The second corrects in addition for the change caused by inflation in the real value of financial assets and liabilities. These two inflation-adjusted series are further adjusted to remove variations caused by cyclical movements in the economy.

Earnings/price ratios based on the inflation and cyclically adjusted stockholder earnings and S&P 500 prices are compared with actual EP ratios to determine if investors make these types of adjustments when estimating corporate earnings. The results suggest that investors take into account the effects of cyclical variation and incorporate inflation effects by adding back deferred taxes, using replacement cost accounting and removing FIFO profits. The results suggest, however, that investors make the irrational error of capitalizing earnings with a nominal, rather than a real, discount rate.