How to measure the earnings power of corporate America

A sour trading update from Apple leaves those advisers and clients who have exposure to US equities – and technology stocks in particular – with a few questions to answer. Although disappointing demand in China grabbed most of the headlines, Apple’s Chief Executive Officer, Tim Cook, also blamed weaker growth across emerging markets more generally, a stronger dollar and a slower-than-expected product upgrade cycle in the West – issues which could affect not just Apple but any US-based multinational.

This is why the forthcoming quarterly reporting season in America will be a particularly important one, as advisers and clients try to get a read on whether the second-half sell-off suffered across US equities in 2018 was merited or not.

Value case

According to research from Standard & Poor’s, the pull-back leaves the US stock market on 14.3 times forward earnings per share estimates of $171 for the S&P 500 in aggregate for 2019.

Source: Standard & Poor’s

  • Bulls will argue that a 9% increase is perfectly achievable, especially with the US economy primed to rack up GDP growth of 2.5% to 3.5% for 2019. Throw in that 9% earnings increase, some multiple expansion from that 14.3 times level if confidence returns – and a dividend yield of around 2.1% – and you can see how forecasts of double-digit returns from US equities for 2019 may easily add up.
  • Bears will challenge that 9% growth estimate by pointing out that the forecast 2018 earnings per share figure for the S&P 500 of $157 already represents a record high. With corporate profit margins of 12.1% in Q3 2018 also a record high, it seems legitimate to ask how US corporate earnings can keep on growing, as the benefits of the Trump tax cuts fade and higher wages, higher interest bills (thanks to the Federal Reserve’s four interest rate increases last year) and the stronger dollar make their presence felt.

Early test

Hopes for a trade settlement between America and China, a softer approach from the US Federal Reserve and the announcement of both fiscal and monetary stimulus by Beijing’s President Xi Jinping have given markets a boost but the imminent fourth-quarter results season will be a good early test for the US equity market – especially as Apple, silicon chip maker Micron (which gave out a profit warning just before Christmas) and Delta Airlines have got it off to a bad start.

Around 30 of the S&P 500 index’s members report quarterly results in the coming week. Most of them are financial stocks, including megabanks Citigroup, JPMorgan Chase, Wells Fargo, Bank of America, Goldman Sachs and Morgan Stanley.

Advisers and clients will be looking for strong numbers here as the banks sector was a terrible stock market performer the world over in 2018 – and if there is one sector that all asset-allocators would like to know is healthy some ten years after the Great Financial Crisis then surely it is the banks.

Source: Refintiv data

Overall, Standard & Poor’s is looking for 26% earnings per share growth, helped by the Trump tax cuts for the final time – the beneficial comparative effect will drop out from the first-quarter results that will be released in April and May.

Source: Standard & Poor’s

Margin for error

The second-half retreat in US equities to around the 2,500 mark on the S&P 500 at the time of writing leaves the headline index some 14% below its September all-time high. And the fact that US stocks are now 14% cheaper than they were makes them more interesting.

However, tempting as that 14.3-times forward multiple may be, there may be still little room for disappointment when it comes to the quarterly reporting season.

The 10% hammering handed out to Apple on the day of its warning suggests as much, as does the work of Professor Robert Shiller.

His cyclically-adjusted price/earnings ratio (CAPE) calculation, which is based on inflation-adjusted historic earnings on a ten-year rolling basis, still argues that US stocks may be perilously overvalued, at 29 times forward earnings.


AJ Bell Investment Director

Russ Mould’s long experience of the capital markets began in 1991 when he became a Fund Manager at a leading provider of life insurance, pensions and asset management services. In 1993 he joined a prestigious investment bank, working as an Equity Analyst covering the technology sector for 12 years. Russ eventually joined Shares magazine in November 2005 as Technology Correspondent and became Editor of the magazine in July 2008. Following the acquisition of Shares' parent company, MSM Media, by AJ Bell Group, he was appointed as AJ Bell’s Investment Director in summer 2013.