We’re about to get a look at what could be the best earnings season in a decade.
Analysts estimate S&P 500 profits rose 66% year-over-year in the second quarter, the strongest growth since 2010.
If you’re cheering historic growth, though, you may be missing most of the story. Markets are forward-looking, and the ground is shifting under corporate America’s feet. Expenses are rising, hiring is slowing, and consumer preferences are changing.
This season, it might be more important to focus on managements’ comments in earnings calls than the earnings releases themselves. Usually, these calls give a more detailed, intimate look into how a company is operating and what the C-suite expects in the coming months.
We’ll give you a little cheat sheet: Here are three buzzwords that could be popular (and meaningful) in upcoming earnings calls.
One of the biggest gems on earnings calls is the company’s outlook on sales and profits. And when investors are nervous about the future, they listen extra closely for guidance.
Guidance became somewhat of a lost art during COVID, but now more companies are back to issuing projections. In fact, about 100 S&P 500 companies have given second-quarter guidance, nearly double the amount that gave their outlooks for the same quarter last year.
Company projections have been overwhelmingly positive, too. The percentage of S&P 500 businesses that have issued second-quarter guidance higher than Wall Street’s estimates is around the highest in 10 years.
However, the jury is out on what the rest of the year will look like, and executives may paint a different picture of performance this season. Economic growth is expected to slow after an epic boom in demand last quarter, and the next phase of the business cycle could make it tougher for some companies to keep growing at these paces.
On that note, pay special attention to how the company is spending its cash. S&P 500 companies are sitting on a $2.3 trillion mountain of cash. Lately, they’ve spent it more on shareholder-friendly activities like stock buybacks and dividends. While there’s nothing wrong with that, a company eyeing long-term growth could get bigger bang for its buck with capital expenditures (or investing in research and equipment).
Shortages are front and center in companies’ minds, and for good reason.
The economy has been in the middle of a historic labor shortage for most of this year with no end in sight. Companies have struggled to hire workers for many different reasons: pay, safety, family concerns, stimulus checks.
Labor isn’t the only scarcity, either. Businesses around the world are struggling with materials and goods shortages as well. The chip shortage is still crimping the manufacturing of cars, tech gadgets and appliances (among other products).
No matter the reason, hiring could be an issue that could start leaking into income statements. First, a lack of resources could effectively put a cap on sales (and profits). Demand may be high, but it doesn’t matter if a business doesn’t have enough workers or product to service that demand.
Also, companies have turned to pay raises to close the hiring gap, especially in service industries like restaurants and hospitality. Higher pay is good news for consumers, but bad news for a company’s bottom line. On average, wages make up about 70% of business costs, so payroll expenses can add up fast.
Look for executives to share some insights on how shortages are affecting their businesses, and when they see these abnormal dynamics settling down.
Speaking of costs, earnings may depend more on how well a company manages its expenses (versus the demand for its products).
Costs could be a challenge, too. Wages are on the move, and prices of raw goods are rising at the fastest clip in 12 years. Companies are trying to pass along these costs to customers, evidenced by the core Consumer Price Index’s biggest jump in decades. But companies may be having mixed success striking the right balance between price increases and demand.
If your stock’s executives are lamenting higher costs, take a look at the stock’s profit margins – or how much the company is generating in earnings per dollar of sales. If margins shrink while sales are steady, it could be a sign that costs are eating into profits.
Overall, S&P 500 profit margins have been strong, and there could be some wiggle room for higher expenses. But in the past, the stock market hasn’t reacted well to declines in profit margins.
And even if S&P margins stay steady, the story could be different by industry. Margins for certain sectors like retailers and auto manufacturers could take an outsized hit in future quarters as businesses process a few months of higher costs.
The Bottom Line
While it’s expected to be a historic earnings season by many measures, don’t be surprised if you see stocks get punished because of disappointing details or outlooks from earnings calls. Investors are understandably nervous about the future, and with expectations so high, the risk this season may be greater than the reward.
If you’re feeling overwhelmed by the uncertainty, try to re-frame volatility as opportunity, especially if you’re investing for longer-term goals. Of course, investors should always keep their individual goals and needs in mind, even when navigating earnings.
Long-term, lower earnings growth is nothing to fear, especially with profits likely growing at a double-digit rate through the end of the year. Healthy earnings growth could give crucial long-term support to this market, even if second-quarter results give the market some indigestion.
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During her tenure as president of Ally Invest, Lule led Ally Invest Securities, Ally Invest Advisors and API business lines. She also authored several articles about the investing industry and investor behaviors. Lule has a passion for agile product development and an appreciation of design thinking in shaping user-centric experiences. An advocate for financial and retirement solutions that rely on a mix of digital and human guidance, Lule believes in empowering individuals, especially women and minorities, to independently drive their own financial futures.
Comment on this article
Scott G. on July 16, 2021 at 1:50pm
Thanks for the information. It's always informative.