Here’s what investors have learned halfway through earnings reporting season
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Traders in the NYSE Floor, Feb. 2, 2022.
Source: NYSE
Thursday marks the halfway mark in fourth-quarter earnings season. Corporate America has plenty of cash. However, the bad news about 2022 is that they don’t seem to be as solid as 2021.
These are the highlights:
Record revenues. Corporate America is flush with cash. The quarter could be worth $3.5 trillion [in total sales] for the first time,” Howard Silverblatt, senior index analyst at S&P Dow Jones Indices, told me, noting that total sales had only hit $3.0 trillion for the first time in the fourth quarter of 2020. Dividend payouts and buybacks are also at record highs.
Companies beat estimates by much less. Companies reporting so far are beating fourth quarter estimates by only 4.6%, according to Refinitiv, far below the 16% beat in the prior five quarters.
It is not expected that 2022 estimates will be raised by as much as 2021.. Earnings estimates for the first quarter have been declining, and they have risen slightly for the second and third quarter.
The profit margins of a company are generally lower but they don’t decrease by much. The second quarter of 2021 saw record operating profit margin of 13.5% in the S&P 500, as many corporations benefitted from higher revenues and lower costs from labor, real estate, and more use of technology. That has reversed somewhat: Corporations are reporting paying more for labor and commodities, which has brought operating profit down to 12.7%, lower but still a healthy level.
What does it all signify?
SFuture earnings and forecasts of dividends can be traded for tocks, which means that Wall Street is more concerned with guidance than reporting earnings.
According to guidance, 2022 will see earnings surpassing 2021’s record. The bad news: earnings are expected to rise by only 8%, a far more modest rise then 2021’s 47% rise in profits.
Stock prices are influenced by rising earnings expectations. Why isn’t the expectation of rising earnings much higher in 2022?
Nick Raich from Earnings Scout tracks corporate earnings and tells me that there are many possible earnings outcomes this year depending on how the Fed raises rates or the ongoing inflation story.
It is leading to uncertainty that is evident in 2022’s up-and down earnings estimates.
I was told by him that while the estimates for the first quarter are declining reflect the realities of inflationary issues and supply chain disruptions, and the numbers for the second quarter and third quarters rising seem like wishful thinking.”
Savita Subramanian at Bank of America Securities agrees: “Analysts are penciling in a temporary blip in 1Q amid Omicron,” she said in a recent note to clients.
However, corporate America appears to be concerned about inflation lingering longer than they expect. 3M’s typical statement is: “We see inflation going downstream now. You’re now seeing it at more locations than you ever saw it before.
Meta (Facebook) made similar comments when reporting earnings after the close last night: “We’re hearing from advertisers that macroeconomic challenges like cost inflation and supply chain disruptions are impacting advertiser budgets,” CFO Dave Wehner said in a press release.
Subramanian also agrees that there is a lot of “wishful thinking” around profit margins, noting there is increasing doubt that corporations will be able to keep raising prices to offset higher costs, particularly labor costs: “What’s harder to swallow is analysts expect margins improving to new highs by 2Q…despite a step-up increase in wages.”
Raich is not convinced that market pricing has been done for the Fed’s rate hike calendar.
He said that the bond market might be pricing in four to five price increases, but the stock markets have not yet fully priced it in. Analysts believe that although the Fed may be tough talking, they won’t go through with the four to five price hikes.
Stocks get more expensive again
The recent rally, and the fact that 2022 earnings are not being raised aggressively, has pushed the S&P into the expensive realm once again, now trading at 20.4 times 2022 earnings, according to Refinitiv. This is well over the historical range of 15-17x forward earnings estimates.
This, says Peter Tchir from Academy Securities is a warning signal.
When high-value companies fail to be seen, it is a sign of a missed opportunity. [like Paypal or Meta]”They get hammered,” Tchir explained to me. This tells me large parts of the market remain overvalued.
How can earnings expectations be moved higher? Tchir mentioned a bottoming in China and a weakening of the omicron, which would help to ease inflation and supply chain pressures. It would result in more job opportunities, which could support spending.
Regardless: “You definitely have a headwind on asset prices from the Fed, and there is no way to get around that for the next few months.”
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