No matter how you look at it, the first-quarter earnings of S&P 500 companies do not look good.
First-Quarter Earnings Explained
Among the 447 companies that have reported first-quarter earnings for 2015, 71% beat their estimates. Moreover, 45% have sales above their estimates. (Source: Factset, May 8, 2015.)
However, when you add it all up, the blended earnings growth rate is just 0.1%, which is the slowest earnings growth rate since the third quarter of 2012.
Also, despite 71% of companies reporting that their earnings per share (EPS) beat estimates, the percentage is below the five-year average of 73%.
Revenue is even worse. The blended revenue declined 2.8%; this was lower than the already dismal estimate of -2.6%. The drop in revenue is the sharpest since the third quarter of 2009! The percentage of companies reporting above-estimate revenue (45%) is well below the five-year average of 58%.
The biggest winners in this quarter are in the healthcare and financial sectors, while the biggest loser is the energy sector.
The Pusher: Stock Buybacks
Mind you, you shouldn’t be fooled by the earnings growth figures. They aren’t showing the entire picture.
You see, companies on the key stock indices have been involved in the financial engineering of their corporate earnings. One way they have been doing this is by buying back their shares. Understand this: when companies buy back their shares, their earnings per share automatically look better even if their net income hasn’t increased or, in some cases, has declined. To give you some perspective, in the fourth quarter of 2014, 72% of S&P 500 companies participated in share buybacks. (Source: Factset, March 16, 2015.)
Share buybacks also affect price-to-earnings (P/E) ratios. The 12-month forward P/E ratio is at 16.8, above the 10-year average of 14.1. Since EPS is overstated due to buybacks, the already-high P/E ratio is likely to be understated.
Another thing investors need to really pay attention to is revenue. Revenue is slumping, telling us that companies aren’t selling as much. This shouldn’t go unnoticed.
The future is not so bright: 70% of companies are issuing negative EPS guidance for the second quarter.
Fundamentally, the U.S. economy is growing at a disappointing rate—0.2% in the first quarter.
The world economy is not helping either. GDP growth in the eurozone is expected to be 1.4% in 2015. Note that S&P 500 companies generate about 13% of their revenue from Europe. The problem in Europe will affect U.S. businesses.
China, another huge market for companies listed in the S&P 500, is also slowing down. Its central bank has lowered interest rates three times in six months, and growth is still yet to pick up.
Combining everything, you have to be slightly skeptical when the stocks are standing at their all-time highs. The fundamentals suggest key stock indices are simply irrational, and they are going higher for all the wrong reasons. Investors should remain cautious.