The first-quarter earnings season swings into high gear this week, giving investors an opportunity to price stocks based on something other than macroeconomic variables like inflation and interest rates.
So far, the earnings reports from two of the most high-profile stocks, Netflix Inc. and Snap Inc., were a mixed bag. Netflix jumped more than 7% on the back of a report that showed a smaller-than-expected decline in subscribers, while Snap crumbled 39% after it warned that the digital ad market was slowing much more dramatically than many had anticipated.
After that lackluster start, the earnings season continues this week with reports due from a number of titans, whose impact on the markets will be even more significant than Netflix or Snap. Investors will see reports from Alphabet Inc. (Tuesday), Microsoft Corp. (Tuesday), Meta Platforms Inc. (Wednesday), Apple Computer Inc. (Thursday) and Amazon.com Inc. (Thursday). Those five stocks alone make up more than a fifth of the SPDR S&P 500 ETF Trust (SPY) and other funds that track the S&P 500.
Alphabet and Meta’s quarterly results will be scrutinized by investors to see whether Snap’s advertising woes are more company-specific or emblematic of the industry.
Microsoft’s report will offer key insights on the status of the enterprise software market, while Amazon’s cloud computing division will provide color on tech spending, and the performance of its e-commerce business will be a signal about retail sales.
Apple, the world’s largest publicly traded company, will give investors clues about how supply chains are faring and how global consumer demand is holding up.
Earnings Growth Slowing
Along with the five behemoths, another 170 S&P 500 companies will report earnings this week.
So far, 21% of S&P 500 companies have already reported earnings, according to FactSet, and of those, 68% have reported earnings above analyst estimates. That’s less than the five-year average beat rate of 77%.
At the same time, the rate of growth in earnings in Q2 compared with the same period a year ago is tracking at 4.8%—the slowest pace since the fourth quarter of 2020.
That’s below the 10.9% growth in revenues, suggesting that profit margins are being compressed.
"Most CEOs are still seeing very high input-cost inflation, very high raw material-cost inflation," Goldman Sachs’ Global Research Investment Equity Strategist Sharon Bell told CNBC.
"The last couple of quarters, companies have passed through most of it. Because employment has been strong, the economy has been strong, consumers have had savings — so they've been able to pass through most of that to the consumer.”
She noted it will become more difficult to pass that through to the consumer and they are “expecting margins to be squeezed."
As usual, Q2’s earnings growth isn’t even across sectors. The energy sector is expected to grow its profits at the fastest rate, followed by industrials. Financials, consumer discretionary and communications services are expected to see the slowest growth, both in Q2 and throughout 2022. In fact, profits at firms within those sectors may actually decline, if analyst estimates are correct.
Earnings are the lifeblood of the equity market. Long term, the ultimate driver of share prices is cold hard profit.
However, in the short term, that relationship doesn’t always hold. Multiples—the amount investors are willing to pay for a given amount of earnings—can go up and down significantly for all sorts of reasons, and their movement often overwhelms any change in profits.
This year, energy is by far the best-performing sector in the stock market, with a 33% gain for the Energy Select Sector SPDR Fund (XLE). But while energy stocks have responded to the rise in energy profits, the same can’t be said for other sectors.
For instance, the information technology sector is down more than 22% this year despite an anticipated 10% growth in earnings for the sector. Similarly, profits for industrial companies are forecast to rise nearly 33% this year, but the sector is expected to decline by 14%.
There are a number of reasons stock performance might disconnect from earnings growth in the short term.
Perhaps the growth is already priced in; or investors don’t anticipate the growth to last; or they just aren’t willing to pay for the growth due to various factors.
In the case of high-growth technology stocks, rising interest rates have reduced the value of future earnings, dampening the multiples that investors are willing to ascribe to those businesses.
So, yes, over the long term, earnings are the primary driver of stocks, but that says nothing about the short term.
For a snapshot of sector and earnings performance for 2022, see the table below:
|Ticker||Sector||Q2'22 EPS Growth*||FY 22 EPS Growth*||2022 YTD Return (%)|
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