Q: I know the economy is doing well right now, but it seems like earnings growth has been really strong -- almost too good to be true. What am I missing?
If you've been following some of the earnings releases in recent weeks, you may have noticed some pretty outstanding growth numbers, such as 40%, 50%, or even more earnings growth over the past year. Even some companies that generally put up low-double-digit growth in strong years are increasing profits rapidly.
However, in many cases the growth isn't quite as stellar as it appears.
The reason we're seeing some astronomical earnings growth rates is a combination of actual business growth and the effects of tax reform -- specifically, the reduction in the corporate tax rate from 35% to 21%.
For example, Bank of America recently reported second-quarter earnings that grew by a staggering 43% from the same quarter last year. However, only a small portion of this was fueled by revenue growth and expense reductions -- the majority was because of the bank's effective tax rate falling from 37% to 20%.
So when you see great earnings growth in 2018, it's important to look beyond the headline earnings number. Did the company's revenue grow? Did expenses (other than taxes) drop significantly?
To be clear, most companies are doing quite well in terms of growth -- but they aren't growing quite as fast as the earnings numbers indicate.