4 Themes to Follow as Corporate America Reports a Surge in Profits
Posted July 23, 2018 7:18 p.m. EDT
Updated July 23, 2018 7:19 p.m. EDT
The quarterly earnings season is upon us once again, and analysts expect the strong economy and Trump administration’s tax cuts to lead to another batch of knockout earnings reports.
Per-share profits at companies in the S&P 500 are forecast to have risen 20.8 percent in the second quarter compared with a year earlier, according to analyst estimates compiled by the data provider FactSet through Friday. That would be the second straight quarter of 20-percent-plus jumps, something that hasn’t happened since late 2010.
Tax cuts aren’t responsible for all of that growth. Measures of sales, which are closely tied to the health of the economy, are also expected to rise at a robust 9 percent in the second quarter, compared with the prior year, according to FactSet.
Despite those leaps in sales and profit, the S&P 500 remains below the highs it hit in late January. Earnings reports look backward, and what really matters to investors is what lies ahead. These days that means companies have to consider a growing trade conflict and rising interest rates, wages, commodity prices and other costs that are clouding the economic outlook.
Just which of these worries is front of mind is something that investors will be listening for as they dial into the conference calls with executives that typically follow earnings reports. Those calls might also yield some insight into what’s happening with wages and investment.
Here are some key themes to listen for.
— The Trade War
So far the Trump administration’s trade war hasn’t sunk the stock market, as many had predicted it would. Sure, there are pockets of trouble. Shares of the construction equipment company Caterpillar have struggled in part because the firm is considered doubly vulnerable to trade tensions; more than 50 percent of Caterpillar’s sales last year came from outside North America. The company is also a large consumer of steel, which has risen in price thanks, in part, to Trump administration tariffs on imports.
Still, the pain has been relatively limited so far, and not everyone will see this as bad news. Shares of small companies, which tend to sell most of their products domestically, have done well.
But analysts and investors will be listening closely for any other indications that the expanding trade war is starting to delay plans for corporate spending. So far it hasn’t, executives say.
“It is not at this point causing them to change the strategic actions and decisions that they’re making,” Marianne Lake, chief financial officer for JPMorgan Chase, the country’s largest bank by assets, said on the bank’s post-earnings call this month.
With the economic expansion in its ninth year — the second-longest stretch of growth on record — a burst of corporate investment will be a key to keeping the streak alive. Key provisions of the Trump administration’s tax overhaul were designed to provoke such a spending boom on new factories and equipment.
In the first quarter, there was a solid uptick in business investment, though whether it’s because of the tax bill or unrelated developments — such as the rebound in oil and gas prices — is a matter of some debate.
These long-term, big-ticket investments — known as capital expenditures, or “capex” — don’t just mean executives are feeling flush. Because they might take years to yield profits, they also require significant confidence in the economy over the long term, so they are a good clue to where executives think things are heading. It is not clear that companies are rushing to make these kind of investments in plants and equipment.
“We are not yet seeing what I would call a lot of traditional capex spending occurring,” Curtis Farmer, president of the midsize lender Comerica, told analysts on a conference call last Tuesday.
When companies have cash to spend but are not willing to commit to big investments, they often instead buy up their own stock. A surge of buybacks, another byproduct of the tax-bill windfall, helped shore up the stock market earlier this year. When companies buy back shares, they cut the number of shares outstanding, raising earnings per share. The case for a buyback is that this can help push a stock price higher, and a big buyback announcement tends to be applauded by stock investors.
Shares of Warren E. Buffett’s Berkshire Hathaway jumped about 5 percent Wednesday, after the company said it had removed a limit on share repurchases.
Buybacks have their critics, too, who deride them as financial engineering that benefits only shareholders in the short run. Spending that money on new equipment or a factory might create jobs for the workers who will build a factory, say, and those who will be employed in it, and add to profits over the long term.
The quarterly earnings updates contain information about the value of the stocks they bought during the quarter, and sometimes they expand buybacks.
As a result, investors can gauge the pace of corporate repurchases. If a company’s shares have performed only modestly despite a binge of buybacks, that could mean investors’ view of the stock is more pessimistic than the price might reflect.
Wage growth is a key factor in the U.S. economy, as consumer spending accounts for roughly two-thirds of gross domestic product. At the same time, for investors, wage growth isn’t always positive. Rising labor costs can cut into profits, muting the impact of a robust economy. In some sectors, that seems to be happening.
Trucking firm J.B. Hunt Transport Services reported better-than-expected profits last week only to see shares slide after it cited “driver pay and retention costs” and “driver recruiting costs” as some of the outlays that nibbled away at the benefits of higher prices and booming volumes.