Corporate Earnings on Record Pace (CAT, BA)

With earnings season about half complete, let’s take a look at how companies’ first quarter of the year is shaping up.
Of the  companies in the S&P 500 that have reported earnings to date, 83% of reported results above analyst expectations according to Thomson Reuters. If the trend continues, and the quarter ends with 83% of companies beating estimates, it will mark the best quarter for the S&P 500 since at least 1994 (when the data started being tracked). 

Overall, companies are reporting earnings that are an average of 21% above estimates — well above the long-term surprise factor of 2% and the -4% surprise factor recorded over the prior eight quarters. Since January 1, the sectors with the highest dollar-level increase in earnings have been the financials (+$9.1 billion), information technology (+$4.2 billion), and consumer discretionary (+$2.4 billion). 

The revenue picture also looks good: 69% of the S&P 500 companies that have reported to date have beat revenue expectations; 31% reported revenues below expectations. Overall, revenues are beating expectations by 3%. 

Looking ahead, stocks in the aggregate don’t look expensive. The forward four-quarter price-to-earnings ratio for the S&P 500 stands at 13.8 — which is below the average of 14.7 seen over the last 52 weeks. Skeptics can say what they will about the technically overbought nature of the stock market; the fact is that the huge 80% rally out of the March 2009 low is fully justified based on the fundamentals. 

It’s as if the stock market were a video game character that has to pass through various checkpoints to get new “health points” that maintain its strength. Every time now that it passes through the gantlet of earnings of announcements, its “life force” gains energy that propels it forward more strongly than ever.

Moreover, with the labor market on the verge of a hiring boom, with leading economic indicators still flashing green, and companies slimmed down, profitability is poised for another big boost as revenues move higher. It’s the concept of operating leverage: Companies like Caterpillar Inc. (NYSE: CAT) and The Boeing Company (NYSE: BA) have big expensive factories and machinery that are billed against revenue each quarter regardless of whether they are actually producing anything. So when production actually ramps up, earnings can grow much faster than revenue. 

In short: Corporate profits are set to rise for a long time even if interest rates begin to slowly rise. Stock prices will follow after the current correction is complete.

For more ideas along these lines, check out my Trader’s Advantage and Strategic Advantage newsletters.

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