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A Recap, and a Look Ahead

| June 11, 2018
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As many of our readers are aware, the first quarter of 2018 earnings season turned out to be very strong, with earnings growth reaching a seven year high and solid, broad momentum on the revenue side. To quickly recap, the quarter is basically in the books, with 498 of the S&P 500 companies (of which there are 505) reporting results. Remarkably, total earnings are up 24.4% from the same period last year on 8.7% higher revenues.

Even excluding the energy sector, which saw 75% earnings growth due to easy comparisons from abnormally low 2017 levels, total S&P 500 earnings growth is up an incredible 22.7%. A full 77% of those S&P companies beat earnings per share (EPS) estimates and almost 75% beat revenue estimates. It will be a long time, probably coming out of a recession, before we see results like that again.

Small-cap results are even more impressive, fully justifying inclusion in MPCA portfolios. For the small-cap S&P 600 index, we now have results from 97% of the index’s total membership. Total earnings for these companies are up 31% on 9.3% higher revenues, with 54% beating EPS estimates and 72% beating revenue estimates. More impressively, in addition to earnings and revenue growth, revenue surprises are notably tracking above historical periods for the small caps.

In classic “what have you done for me lately?” fashion, investor focus now shifts to the Q2 earnings season which, believe it or not, begins with early results in the next few days. While not quite as impressive as the first quarter, total Q2 earnings are expected to be up 18% from the same period last year on 8% higher revenues, and many sectors are expecting double-digit earnings growth. This would be the third quarter in a row of double-digit earnings growth, a trend that is expected to continue into the second half of the year.

For the full year, 2018 total earnings for the S&P 500 companies are expected to be up over 19% on 6% higher revenues. For 2019 and 2020, earnings are expected to be up almost 10% for each. Revenues for the index are expected to be increase by 4.5% in 2019, and 4.6% in 2020. Needless to say, we would be more than happy with such results.

At MPCA, the willingness (or not) of investors to “pay up” for earnings matters, as well as the magnitude of earnings themselves, and we track both closely. So, with fair warning, here is a little valuation math for interested readers. Price to earnings (“P/E”) ratios tell us a lot about investor enthusiasm, and the P/E for 2018 earnings currently stands at 17.7 times, historically high but not excessively so in our minds, assuming earnings growth meets expectations (a key “if”). Overall, S&P earnings are projected to come in a $156.64 “per share”, an unthinkable number just a few years ago.

Using the same methodology, the index EPS works out to $171.75 per “market share” for 2019, with a corresponding P/E of 16.1 times. For 2020, the numbers are $188.40 for earnings and a P/E of 14.7 times. Long story short: if earnings come through as expected, the market’s valuation does not scare us off yet.   

The chart below hopefully illustrates the previous point about earnings. It compares the Q1 earnings growth rate with what was actually achieved in the last five quarters and what is expected in the coming three quarters.

The forward-looking growth picture remains very strong, even though it is expected to decelerate in the coming quarters from Q1’s lofty level. The one potentially concerning aspect here is not the deceleration from a very strong Q1, but the underwhelming earnings revisions trend for Q2 and beyond that we are seeing so far as companies report. The cautious revisions are likely related to the ongoing strength in the U.S. dollar and questions about the global economy. Those looking for an explanation for the market’s less than enthusiastic reaction to Q1 results can likely find it here. As for us, we remain vigilant, as always.

Data from Zacks Investment Research was used in compiling this report.

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