US company profit reporting season: higher than expected but still negative
US markets conduct their company profit reporting season quarterly, instead of half-yearly as it is in Australia. They are in the midst of their Q2 reporting season now.
The recent stellar run on the US market - S&P500 reaching new highs and approaching the 2200 mark - has been buoyed in recent days by the quarterly results.
This brief piece considers the status of the US reporting season (noting Australia's 30-Jun-16 reporting starts in earnest in the next couple of weeks).
Performance to date
According to Thomson Reuter's Earnings Aggregates Report (dated 20-Jul-16), 67% of S&P500 companies that have reported to date have beat expectations.
Well known names such as American Express, Morgan Stanley, Johnson & Johnson, IBM, Bank of America, Yum Brands (fast food), Alcoa and Nike beat consensus expectations. There have been some disappointments, such as Netflix (lower new subscribers than expected), Southwest Airlines and Pier 1.
However, this does come with an element of caution - only 70 of 500 companies had released their results, including only one in the energy sector (and with the profit of energy companies generally lagging oil price increases, we see risk here).
But of a base that had been revised down
This graph appears at first glance quite complicated, but it is fairly simple. It depicts how earnings estimates for each quarter of FY-16 have been revised down, as the earnings release date draws nearer.
Disturbingly, this trend happens more often than not.
So, although the earnings figures recently released are beating expectations, it should be noted that it is off a base that has been revised down quite meaningfully over the last year or so.
Growth rates - past and future
As we are longer-term investors, we believe consideration of earnings growth rates is more important than performance against expectations in a given quarter. After all, it is earnings growth that fundamentally and over time will drive share price increases.
And this is where we see a red flag.
Firstly, earnings growth over the past year has actually not been that - instead it is mostly backwards, including for the current quarter. That is, profit growth is negative.
Furthermore, future earnings growth expectations are high. These are dependent on a really strong recovery in earnings in the materials and energy sectors especially, and also robust growth rates in other sectors such as financials and consumer discretionary.
Earnings growth from companies in the materials and energy sectors are dependent on commodity price increases, i.e. there is meaningful risk to expected earnings growth rates if commodity prices don't rise materially from here. We believe the graph above is highly likely to repeat for FY-17.
The quarterly growth rates (and expected) of the S&P500 companies are depicted in the graph below.
Growth rates vs market performance
The bottom line is that we consider the current level of the S&P500 is inconsistent with the future earnings growth rates - especially when you consider the risk to the growth rates.
The P/E of the S&P500 (one year forward) is 17.1 - expensive. There is little leeway in this for a downwards revision to earnings.
This is one of the reasons that, in relation to investing at the moment, we are cautious.