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This article first appeared in the Telegraph
THERE comes a moment in each quarterly earnings season when, with the best will in the world, you just can’t keep up. For me, it’s about two weeks in. The early trickle of results has turned into a torrent. We’ve had a look at the banks, which are always first out of the blocks, and the tech wave is just getting underway. Apple, Amazon, Alphabet, Facebook, Tesla and Microsoft vying for our attention in a couple of frantic days.
And that’s just on the other side of the pond. The Americans are generally quicker to add up the numbers than we are over here but by the time we get to this point things are kicking off over here too. On this side of the Atlantic as well, it’s a bewildering fog of figures.
This, of course, is where we are right now. And I’m mighty glad that I’m not an analyst looking for an information edge in this blizzard of data. The most I can hope for is to get a sense of the direction of travel. Are things better or worse than expected? And what are we learning about the outlook for the rest of the year?
The good news is that, a quarter of the way through the April to June results season, it looks like we are heading for the best aggregate corporate growth for more than a decade. The better news is that things are turning out even better than already high expectations for the second quarter. This latest set of earnings is, for the fifth quarter in a row, smashing the spreadsheets.
A couple of weeks back, as the first results hit our screens, the expectation was for profits to emerge about 63% ahead of the same three months last year. That would have been an exceptional quarter by any reckoning but now it looks like being way too pessimistic. The latest forecast is closer to 80% and I wouldn’t count on the improvement stopping there. With about 120 of the S&P 500’s constituent companies now in the bag, nearly 90% of results have come in ahead of forecast, an average of 20% better.
The financials, including the banks, which got things going, have done even better. More than 90% have beaten expectations by an average of 31%. Even before this week’s FAANG-fest, every single technology company to have unveiled its earnings had beaten the consensus and the results so far this week have been stellar. Of the industrial companies to have announced, 82% have surprised positively.
This is a well-trodden path. As results for the January to March quarter came in three months ago, the expected earnings growth rose from 24% to 54%. No wonder that for the full calendar year growth is now pencilled in at 40%. We haven’t seen anything like it since the last time we were emerging from the abyss in 2009.
Now beating earnings is nothing new. Company bosses know that the best way to keep their share price (and their options) heading in the right direction is to manage expectations. No-one is particularly surprised if profits emerge 3-5% better than forecast. That’s part of the game. It is the scale of the beats in the past few quarters that is really remarkable. So, what is going on?
First, it seems that contrary to all the widely publicised concerns about rising input costs companies have managed to pass on higher commodity prices, rising wages and the cost of broken supply chains to their customers. With a strong labour market and high household savings, consumers have been prepared to swallow the price hikes.
Typically margins for America’s biggest companies are around 10%. In the first quarter they were 13% and the latest figures suggest something similar. Pricing power has come to the rescue.
Second, while raw material costs may be rising, other expenditures have been significantly reined in during the pandemic for many businesses. Less travel and more Zoom, more people working from home and in some cases fewer people working at all. All of these have contributed to a material improvement in companies’ operating leverage - as sales have improved, more of those revenues have dropped through to the bottom line. In the last two years, America’s biggest companies have generated 17% earnings growth from just a 3% improvement in sales.
Third, while sentiment has been hit by a resurgence of infections as more contagious variants have got a grip, it is the more muted impact on hospitalisations and deaths that has been more important for many businesses. The numbers with Covid are not really the problem. It is the lockdown measures required to contain it that hit the bottom line.
Fourth, this is feeding through into expectations for the third and fourth quarters. Three months ago, we expected the July to September quarter to see earnings rise by 20%. Now that looks like being 27%. The final three months of the year were due to deliver just 13% growth. Now it could be 20%.
It is always better to travel than to arrive in investment and, to use the ice hockey analogy, it is better to skate towards where the puck is going than to focus on where it is. So, the improving outlook for the next six months is even more important than the better than expected results for the past three. We may still be at peak earnings but the drop off from here looks like being slower and shallower than we feared.
We have certainly moved beyond the hope phase of the stock market cycle that was responsible for last year’s V-shaped market recovery. Now, we are in the growth phase. Less exciting maybe, but more durable. We’re still travelling.
Important information: Investors should note that the views expressed may no longer be current and may have already been acted upon. Overseas investments will be affected by movements in currency exchange rates. Investments in emerging markets can be more volatile than other more developed markets. Reference to specific securities should not be construed as a recommendation to buy or sell these securities and is included for the purposes of illustration only. This information is not a personal recommendation for any particular investment. If you are unsure about the suitability of an investment you should speak to a Fidelity adviser or an authorised financial adviser of your choice.
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