By: Dividend Sensei
As an investment writer/analyst earnings season is my favorite time of the year. That’s because not only does it provide us with updates on the companies we own, but Wall Street’s short-term focus on silly things often creates incredible buying opportunities to pick up Grade A dividend growth stocks at a bargain. This earnings season in particular is seen as more important than most, due to heightened uncertainties surround tariffs, a rising dollar, and fears of peaking corporate margins. So to help you navigate this potentially volatile next few weeks, here’s the three most important things for investors to know.
What Wall Street Is Expecting
As of last Friday (October 12th), 6% of S&P 500 companies had already reported. Here’s how those results broke out:
- 68% beat on revenue (average 0.4% beat), 86% on EPS (average 2.1% beat)
- FactSet is estimating (based on initial reports) 19.1% YOY EPS growth in Q3 (third highest since Q1 2011), fueled by 7.3% YOY revenue growth
What about full year 2018, and more importantly 2019 estimates?
While many might point to slowing revenue and EPS growth in Q4 and 2019, as a potential concern, it’s important to remember two things. First, the vast majority of companies have been beating EPS growth expectations this year, which bodes well for the full year’s results coming in over 20%. Second, 2018’s blockbuster results were largely due to tax reform, which is a permanent, but one time event. Thus it’s important to keep 2019’s projections in context. Since 2002 the average annual revenue growth rate for the S&P 500 has been 3.3% while annualized EPS growth has been 7.5%. Thus in 2019 both revenue and earnings growth is expected to come in nicely above their recent historical norms.
More importantly, those earnings growth projections mean that on a forward PE basis, the S&P 500 is currently trading at safe levels:
- Forward PE: 15.7
- 5 year average: 16.3
- 10 year average: 14.5
Now it’s true that on a trailing 12 month PE basis the S&P 500 is at 22.9. That’s high by historical standards (40 year average 20.2). However, remember that tax reform means that 2018’s bullish earnings projections are not pie in the sky guesses by analysts, but far more likely to come true. This is why in 2018 I’m focusing on the forward PE ratio. While the market’s forward PE is higher than the 10 year average of 14.5, it’s hardly at dangerous levels that signal we’re likely in a bubble. And keep in mind that average includes 2018’s 77.5% EPS plunge during the Financial Crisis when most banks reported historic losses. In 2019 the 10 year average EPS will soar as 2008’s figure rolls off into history.
The bottom line is that corporate earnings are booming, and mean that stocks are not nearly as overvalued as many fear. They are certainly not in dangerous bubble territory that indicates another 50+% market crash is likely. While another bear market is certain to eventually happen, it’s likely to be a run of the mill downturn, which since WWII has meant an average peak market decline of 33%.
But of course what has investors especially concerned isn’t just the actual sales and earnings results, but what companies say in terms of future effect of tariffs, a strong dollar, and cost pressures that might squeeze margins. So let’s take a look at each of these risk factors to see what investors need to watch for.