By: Dividend Sensei
I’m not a big fan of earnings season. In my view this quarterly look at a company’s results creates the very short-term bias that is the root cause of so many regular investors underperforming the market in the long-term. After all, owning shares means owning a piece of a real, tangible company. One that you plan to own for years, decades, or even forever.
And with Wall Street analysts often trying to parse every little tidbit out of each release, (plus the quarterly conference call), it mainly just creates a lot of useless noise. In fact the only reason I’m not against companies moving to an annual reporting system is purely because of all the crazy price swings that market overreactions to earnings can create. This often results in fantastic buying opportunities for those of us who are smart enough, but more importantly, patient enough, to ignore this quarterly circus.
However, on rare occasions earnings season can shed important light on broader trends. That’s the case with the current period, but not because of the results of any one company.
Why does this earnings season matter? Because we just exited an earnings recession that lasted for six months. In addition, the market’s recent rally was predicated on the EPS boosting effects of promised fiscal stimulus, including: a 75% decrease in the corporate tax rate, large scale deregulation, and massive infrastructure spending.
However, as the recent failure of healthcare reform shows, getting anything important done in Washington is much easier said than done. In fact, Treasury Secretary Steven Mnchin, who is leading the tax reform effort, has pretty much admitted that getting reform done by August (it was originally supposed to be done by May, before the timeline was pushed back), will be impossible.
And given that the last time tax reform passed, back in 1986, it took two years and that was with massive bipartisan support. The reason that tax reform is so much harder than simply cutting taxes, is because rather than just tweaking rates within the present framework, reform means completely changing the rules. Specifically the goal is to simplify the code, and make it more efficient, and thus able to generate the same revenue with less economic impact, (faster growth).
Right now the plan, as far as we know, is for corporate and individual income tax rates, to be lowered, with the revenue made up by the elimination of almost all deductions (as well as a 20% Border Adjustment Tax). However, remember that the reason the tax code is 75,000 pages long is because lobbysts have spent nearly a century inserting special favors for their clients.
Thus every excemption eliminated means someone’s sacred cow is getting gored, and some constituency is going to be upset, and fight tooth and nail to keep their perks.
So what does this have to do with this quarter’s earnings season? Well, analysts were originally predicting solid 9.0% year-over-year EPS growth (for the S&P 500 as a whole).
So while any individual company’s earnings report might be largely irrelevant (to your long-term investment strategy), taken together they will tell us how well corporate America is able to grow without any fiscal stimulus. That means that whether or not the bull market can continue its run could come down to whether or not this quarter shows that America’s largest companies can go it alone, without help from tax reform.
So how are things looking now?
Well, according to Factset Research (FDS), as of April 13th (most recent available data) 6% of S&P 500 companies have reported earnings, and 59%, and 76% of them, have beaten their sales, and earnings targets, respectively. In fact, thus far the blended EPS growth rate, (accounting for market cap size) is 9.2%, the second highest since Q4 of 2011 when earnings grew 11.6%.
Of course 94% of companies are not included in that study, and those positive figures are being highly skewed by a few key sectors, such as buildings products companies, whose earnings growth has thus far been 72%.
So while it’s too early to celebrate, thus far the data has been positive, indicating that despite slowing US economic growth, and a failure of Congress to do something positive (no big shock to anyone), corporate profits do seem to be moving in the right direction. And in these increasingly uncertain times, that’s something for long-term investors to celebrate.