Key takeaways
Most S&P 500 companies are reporting second quarter earnings growth, based on early results.
Selected companies, however, experienced earnings disappointments.
Analysts anticipate continuing profit growth through 2024 and into 2025.
Less than half of U.S. companies reported second quarter earnings (a measure of corporate profits) by late July, and while results were generally positive, there is some dispersion in earnings outcomes. Overall, second quarter earnings for reporting S&P 500 companies, to date, rose 9.8% from 2023’s second quarter. While investors still await reports from much of the S&P 500, growth of nearly 10% would be the fastest rate of year-over-year earnings expansion since 2021.1
“We’ve seen a number of companies beat earnings expectations, while some have come up short, occasionally by a wide margin,” says Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management. “At this later stage of the bull market cycle, investors are having to think more about distinguishing between winners and losers.”
The U.S. economy’s continued resilience in the face of high interest rates and persistently elevated inflation has been supportive of a favorable earnings environment. The economy gained momentum in 2023, but after generating tepid Gross Domestic Product (GDP) growth of 1.4% in 2024’s first quarter, GDP gained 2.8% in the second quarter.2 Earnings growth has improved in recent quarters, fueled by the economic expansion, and the forecast remains generally positive.
Investors are hoping U.S. companies can build on favorable earnings results earlier in the year. On average, first quarter 2024 earnings results were solid. Early second quarter results are encouraging as well, though with some high-profile disappointments. For example, the electric vehicle maker Tesla reported second quarter earnings far short of expectations, resulting in a significant setback for its stock. “This reflects challenges specific to Tesla, but also recent weakness in the auto industry as a whole,” says Haworth.
While investors continue to closely monitor factors like economic data and Fed monetary policy, Haworth notes that over the long term, no factor may have more impact on the performance of individual stocks than company earnings. Earnings represent a corporation’s net profits and provide a gauge of the financial health of a company and a stock’s potential performance.”
The environment for corporate profits evolved in recent years. The economic slowdown tied to the 2020 emergence of the COVID-19 pandemic drove earnings lower. As the economy recovered, inflation soared, leading the Federal Reserve to push interest rates significantly higher. Slower economic growth resulted, tempering the pace of corporate earnings growth in 2022, a trend that continued until 2023’s third quarter.
“We’ve seen a number of companies beat earnings expectations, while some have come up short, occasionally by a wide margin,” says Rob Haworth, senior investment strategy director for U.S. Bank Wealth Management. “At this later stage of the bull market cycle, investors are having to think more about distinguishing between winners and losers.”
Based on analysts’ estimates, “S&P 500 earnings are projected to come in above $240 per share in 2024 — about a 10% improvement from 2023,” says Haworth. Yet, he notes that some challenges remain given the economy's modest growth rate, persistent inflation and elevated interest rates. “The general expectation is that the rate of economic growth will moderate in 2024 from 2023’s 2.5% level,” says Haworth. “If the economy ran into more challenges, current expectations for 2024’s earnings growth may be overly optimistic.”
However, Haworth also notes that if a recession is avoided, investors may conclude earnings expectations were too pessimistic, and favorable earnings surprises could result. Often when that occurs, the stock market reacts positively.
The publicly traded companies represented as stock holdings in your portfolio deliver quarterly financial statements that include a wide range of information. This includes a breakdown of sales (revenue) and expenses, the two key factors that determine earnings.
Earnings information is important because it provides a glimpse into the company’s business success in recent months. In many cases, companies provide “guidance” regarding their future earnings and growth prospects. This guidance serves as a preview of what may come based on trends companies experience in their businesses. While corporations often provide earnings guidance, it is not a requirement. According to FactSet, as of July 19, 2024, only 32 S&P 500 companies provided third quarter 2024 earnings guidance to date. Sixteen of those offered “negative” earnings guidance, a signal to investors that a company’s quarterly earnings for the quarter may be less than initially expected. The 16 other companies provided “positive” guidance, indicating they anticipate better-than-expected quarterly earnings results.1
Professional stock analysts often estimate, in advance, their own expectations for what companies will report each quarter. “Investors are very attuned to the forward-view of earnings, which reflects the stock market as a discounting mechanism,” says Haworth. In other words, stock prices are based less on a company’s past performance and more on expectations of future financial success. “Stock prices typically incorporate a consensus market belief about the future state of a company, including earnings, growth prospects, risks, pricing challenges and other factors,” says Haworth.
Earnings provide the basis of one of the major measures of a stock’s individual value. Investors often use a statistic known as the price-to-earnings (P/E) ratio to help assess how expensive a stock is relative to the rest of the market. In other words, it is the ratio of the current price of a stock compared to the company’s earnings. If a stock is trading at $30 per share and the company’s annual earnings are $2 per share, the P/E ratio is 15.
Haworth notes that P/E ratio is just one measure of a stock’s performance. “We look at a variety of valuation assessments, including sales growth and book value growth, which is essentially a way of estimating the liquidation value of a company.” Other factors would include a company’s cash flow and a stock’s dividend yield.
When trying to assess which of two stocks offer the best investment opportunity based on their P/E ratios, it’s not always an “apples-to-apples” comparison. “Determining fair value has a lot to do with the underlying growth rate of the industry in which the company competes,” says Haworth. In some cases, investors may be willing to bid up prices based not on current earnings, but on expectations of future profitability. “This tends to be the case, for example, with stocks that invest in new technology that may not have an immediate payoff but offer the potential of future strong earnings if they succeed,” says Haworth. “Other stocks may have lower P/E multiples, but those companies generate steadier earnings, so the payoff on the investment needs to happen in a more compressed timeframe.”
Other variables can be reflected in the earnings they report. “It’s worth reading beyond the headline numbers,” says Haworth. “Unique, one-time events may affect earnings, either positively or negatively.” For example, if a company’s earnings declined due to a one-time major expense, that shouldn’t necessarily reflect poorly on its outlook. Similarly, if a company reports a strong boost to earnings, for example, because it sold off one of its business units, which may not reliably indicate future strength.
As they do with individual stocks, analysts can place a P/E valuation on the broader market. As of June 30, 2024, the P/E ratio of the S&P 500 based on earnings in the prior 12 months was 24.79, while the P/E ratio based on projected earnings for the next 12 months is 21.1.3 Analysts may set different valuations on the market based on varied sets of projections.
With S&P 500 P/E ratios based on projected earnings exceeding 20 times earnings, Haworth says the market may, on the face of it, look expensive, “but we’re in a different state now. Interest rates are elevated and inflation has come down significantly, so higher market multiples (P/E valuations) may be justified.” Haworth notes that technology-related stocks make up more than one-third of the S&P 500’s valuation in today’s market. “These companies are generally expected to realize faster, long-term growth rates, so they are often valued at higher multiples than other types of stocks.” For example, at the end of June 2024, the P/E ratio for the S&P 500 Information Technology sector, based on projected earnings, was 30.0, compared to 21.1 for the broader S&P 500 Index.4
Haworth believes the earnings environment may require a different perspective. “We’re seeing greater dispersion in earnings, with a notable differentiation between winners from losers. The key is whether there’s enough earnings growth to go around to keep the market moving ahead.” Haworth notes that investors should not be overly focused on current earnings. “Investors need to consider not just what companies won and lost this quarter, but what it means for their prospects going forward.”
If the economy continues to grow, Haworth believes it may expand the universe of stocks benefiting from that growth. “In recent times, technology-oriented stocks dominated market performance, but we think we’re seeing some broadening in the market today.” As a result, the U.S. Bank Asset Management Group advises investors to consider an equal weight S&P 500 index fund as part of their diversified equity portfolio. In such a portfolio, all S&P 500 index stocks are weighted equally. By contrast, the benchmark S&P 500 Index is market-capitalization weighted. That means the largest stocks carry the greatest weight. Haworth believes investors may have better potential by avoiding a large position in technology names that dominate the top of the market and carry high valuations following their recent strong run.
As you assess your investment options and how to best position your portfolio, it can be helpful to do so in the context of a financial plan. Talk with your wealth professional to review whether changes to your investment strategy may be warranted to better reflect your goals, risk appetite and time horizon.
Company earnings typically reflect a firm’s net income, or the money it makes after costs are deducted. The calculation begins with revenue generated over a specific period of time, usually one quarter (13 weeks). Then the cost of sales, operating expenses, interest costs and taxes incurred over that same time are deducted from revenue to determine earnings.
Essentially, they are the same. Other terms used that are comparable to “earnings,” are “net income” and “the bottom line.” Investors will sometimes consider other variations on “profits.” For example, gross profits reflect the direct costs of sales incurred to generate revenue. A higher gross profit reflects significant efficiency in creating products and services that generate revenue. Operating profit takes into account indirect costs, such as marketing and administrative expenses. Net profit is a calculation of operating profit minus interest and taxes. Operating profit is the equivalent of corporate earnings.
As investors assess the financial health of a publicly traded company, earnings, which reflect the “bottom line” for a company, off a the more complete picture. Revenue reflects a company’s income. When calculating earnings, various expenses are deducted from revenue to give a sense of a company’s profitability. A firm may generate significant revenue, but if expenses are too high, its bottom line will not look as impressive. Investors put the greatest emphasis on a company’s earnings, and the pace of earnings growth over time, in determining the appropriate value of a stock.
With inflation retreating and likely interest rate cuts coming soon, how should investors position their portfolios to capitalize on potential opportunities, while guarding against risks?
A fresh look at managing your cash and investments in today’s changing interest rate environment can help support your pursuit of the goals that matter most to you.
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