Earnings growth of 6-7% does not sound very exciting, but given the challenges corporate America has faced, the nearly complete second quarter earnings season has been a success. The numerous challenges last quarter included a slowing economy, intensifying inflation pressures, ongoing global supply chain disruptions, and a surging U.S. dollar. Still, corporate America delivered the type of upside investors have grown accustomed to in much easier economic environments.
Some of the key numbers include:
- Estimates for S&P 500 earnings per share (EPS) growth coming into reporting season were around 4.1%. That number looks like it will end up at around 6.2%, according to FactSet estimates.
- Revenue grew a very solid 14% year-over-year, well above the roughly 10% expected when earnings season began.
- A solid 76% and 71% of S&P 500 companies beat their earnings and revenue targets, like five-year averages.
- Energy delivered the fastest earnings growth among sectors, nearly quadrupling profits from the year-ago quarter. The sector also posted the second biggest upside surprise among all sectors at 9 percentage points, trailing only utilities.
Profit margins are one of the key factors to watch during reporting season. While published estimates for profit margins were too high, they were unlikely to come down significantly. Estimated profit margins for the second half of 2022 did indeed come down as companies reported, but not dramatically so.
Strong revenue growth in the mid-teens is one big reason why margins are holding up in this inflationary environment. That additional revenue, and the pricing power that helps produce it, provides companies with some margin cushion to help them reach their earnings targets.
Analysts’ estimates no longer reflect margin expansion in coming years. Analysts’ estimates tend to be overly optimistic, but expectations of stable margins are a positive sign for future profitability. That said, earnings targets will be very tough to reach in 2023. Particularly if inflation lingers and the Fed continues to raise interest rates. The pace of improvement in inflation may be stubbornly slow despite some progress toward normalizing supply chains and loosening labor markets.
Coming into earnings season, the overwhelming view from Wall Street strategists was that earnings estimates had to come down substantially. The thought process for many was that earnings drop in a recession, so while 2022 profits may be near consensus estimates, 2023 may see a profit decline.
The consensus estimate for S&P 500 EPS for 2022 is $226. And despite coming down about $8 from its prior high, the consensus estimate for S&P 500 EPS in 2023 is still near $244, despite mostly cautious guidance from corporate America and pretty dour sentiment from business leaders.
In a downside economic growth scenario, something worse is possible. An official recession in 2023 is also possible. Higher taxes from the Inflation Reduction Act will likely trim $2 to $3 off next year’s S&P 500 Index earnings, and fewer buybacks in response to the 1% buyback tax may leave share counts higher and therefore EPS slightly lower. In the meantime, market volatility may present buying opportunities in quality names that generate good cash flow.
- The economic forecast set forth in this presentation may not develop as predicted, and there can be no guarantee that strategies promoted will be successful.
- Data provided by FactSet and LPL Financial, tracking # 1-05320221.
- Indexes are unmanaged statistical composites and cannot be invested into directly. Index performance is not indicative of the performance of any investment and do not reflect fees, expenses.
- US Treasuries may be considered “safe haven” investments but do carry some degree of risk including interest rate, credit, and market risk. Bonds are subject to market and interest rate risk if sold prior to maturity. Bond values will decline as interest rates rise and bonds are subject to availability and change in price.
- The Standard & Poor’s 500 Index (S&P500) is a capitalization-weighted index of 500 stocks designed to measure performance of the broad domestic economy through changes in the aggregate market value of 500 stocks representing all major industries.