Earnings growth accelerating in the US
Earnings growth accelerating in the US
The key driver of stocks is earnings, or what the business generates for its owners. This week, the earnings season kicks off in Finland with Admicom. In the US, the world's largest stock market, the major banks also start the earnings season. The US earnings slump ended in the fall of 2023, and now the focus is on finding signs of accelerating growth. At least that is the basic expectation of investors. The increasingly expensive stock market demands steep earnings growth, while interest rates, which offer an alternative to equities, are also hovering at attractive levels.
Of course, a single earnings period, reporting on what happened in the last three months, is only a checkpoint in the decades-long life cycle of corporate cash flows. But today's results will guide an investor's view of companies' future performance.
Here are some interesting earnings releases for my taste, whose reports and comments I try to catch up on during the earnings season:
4/11 Thursday: Fastenal
4/12 Friday: Wells Fargo, J.P. Morgan, Citigroup, BlackRock
4/15 Monday: Goldman Sachs
4/16 Tuesday: Bank of America, J&J, Ericsson
4/17 Wednesday: ASML, LAM
4/18 Thursday: Netflix, TSMC
4/23 Tuesday: Microsoft, Alphabet, Tesla
4/24 Wednesday: Meta, NOW
4/25 Thursday: Amazon
4/26 Friday: Chevron, Exxon
5/2 Thursday: Apple
In Q1'24, the S&P 500 results are expected to increase by about 4%. In practice, the S&P 500 index excluding the Magnificent 7 gang continues to decline in Q1. The results are dragged down by a couple of years of underperformance in the banking sector after the peak results in 2021. In Q2, the remaining 493 companies should also collectively push for earnings growth.
The forecast for 2024 as a whole is for robust earnings growth of 10%. In 2025, earnings growth is expected to accelerate to 13% and the S&P 500 EPS to hit around $276. Earnings growth will be supported by expanding revenues, but the sustained improvement in profitability is also expected to continue. The S&P 500's operating margin is now around 15%, but is expected to return to its 2021 peak of nearly 17% in 2026.
The analysts and strategists who make the forecasts cannot be accused of being overly cautious! We are in the midst of an earnings boom cycle. Recent economic data does indeed support the picture of an accelerating global economy, from which companies are happy to rake in profits for their owners.
For investors, earnings growth is no secret, as equity pricing, viewed through the barbaric lens of the P/E multiple, is also climbing back to the highs of the 2000s. Stocks are trading at 21 times the projected 12-month earnings. In the 2021 bubble, they were priced at best 24x, and in the bubble of the early 2000s, 25x. The S&P 500 companies are certainly among the world's elite, with some of the hottest winners of the AI boom so far, from NVIDIA to Microsoft, but the current valuation level could be interpreted as requiring continued strong earnings growth for years to come. A sudden economic slowdown, a failure of the AI boom to live up to expectations, or even a sudden further rise in interest rates would be stomach-churning for those buying stocks at current levels.
Here's another interesting chart of the S&P 500 index showing where the most expensive and "cheapest" quintile (fifth) of stocks is based on the P/E multiples. The most expensive stocks are not yet at 2021 bubble levels, but they are 25% away from pre-pandemic levels. Similarly, even the cheapest stocks are already trading at an average of 12x forecast earnings, compared to an average level of 9 in recent years.
I wouldn't say the US stock market is in a bubble, but for an investor looking for good prices, it is generally unattractive.