Don't look now, but first-quarter profits among S&P 500
According to Standard & Poor's, 300 S&P companies have reported first-quarter earnings. Of those, 210 have beaten estimates; 56 have missed. That's one of the highest "beat" rates on record.
So what, some say. Companies systematically guide expectations low in order to look smart when they beat their numbers. And now is a good time to point out that earnings don't miss expectations; expectations miss earnings. "High beat rate + low expectations = so what?" blogger Josh Brown said.
More important is that the extraordinary boom in earnings continues marching without a flinch. Corporate profits are tracking at an 8% growth rate this quarter. Employment is still down several million since the recession began in 2007, but S&P 500 profits are at a new record of $98 per share over the last year. Corporate profits as a percentage of GDP are near a 70-year high of 10%.
For years, a loud and growing group of analysts have pointed to that figure as a sign of caution and worry. The profit boom is unsustainable, they say. Once margins return to a sustainable average, profits will fall, along with stocks.
There are a few rebuttals. One is that low employment and wages are what are keeping margins high. An extension of that is that margins may only fall when companies are forced to hire more workers and give raises to existing staff. That could actually be great for profits. Nothing is better for most businesses than gainfully employed consumers with money to spend.
Second, profit growth may not be as dependent on margins as it seems. All profit growth among S&P 500 companies over the past year came from revenue growth, not margin expansion. S&P operating margins have actually declined over the last 15 months, from 9% in 2010 to 8.7% last quarter. Sales are up 7% over the last year.
How can sales be booming if the U.S. economy is so weak? One word: overseas. Take Apple
International exposure doesn't always mean growth exposure, of course. Most of Europe is either in or near a recession. China's growth appears to be slowing, and is in large part fueled by unsustainable lending. Bob Doll of BlackRock estimates that 70% of the incremental earnings growth among S&P 500 companies will come from abroad over the next five years. But there's no telling how much growth, if at all, there may be.
The most important piece of this puzzle for investors is not how much the S&P may earn, but what the market expects it to earn. Earnings can languish while stocks boom if expectations are low enough, and vice versa. It all comes down to valuations.
There are a couple of ways to view valuations in light of today's earnings boom. Using a standard P/E ratio, the S&P trades at about 14 times earnings. That's pretty normal, if not a little attractive. Using another version of the P/E ratio -- Yale economist Robert Shiller's CAPE ratio, which measures the average of 10 years' earnings adjusted for inflation -- the S&P trades slightly above historic averages:
Source: Robert Shiller.
So earnings are strong, but some people think they may not last, while others do. And stocks may be cheap. Or maybe they aren't. Who is right? Something I wrote last year seems appropriate:
Looking back at the financial crisis, the people who came out relatively unharmed weren't the ones who saw the collapse coming. They were the ones who knew all along that nothing was certain, things change, people act irrationally, markets fail, information is incomplete, and above all, you have to be prepared for the unexpected. The biggest irony is that those who thought they knew the most were the most susceptible to being wrong.
The same is true for stocks today.