Earnings season has been in full force for the past couple of weeks and we are now through a little more than half of the companies reporting (within both the S&P and Dow indices).
The common concern entering the past couple of earnings seasons has been surrounded around the ability of companies to see top line growth. The reason for this is that companies have already experienced improved bottom lines, but this (some argue) has mainly come from cost cutting (firing) rather than actual sales increasing.
So far the S&P 500 has seen 52% of their companies report earnings and we have seen sales increase 3.62% year-over-year among those that have reported. Seventy-one percent of the companies that have reported have seen positive sales growth this quarter.
The consumer discretionary and financial sectors have been the lead drivers in the recent sales growth. Despite having all sectors (except for Materials) currently in the green with regards to sales growth, the discretionary and financials sectors have seen sales growth in excess of 8% year-over-year.
It can be difficult for some people to determine whether or not the current earnings season is successful or not because all analysts tend to look at different aspects of the earnings data. Some analysts are more concerned about revisions, while others want to see greater quarter-over-quarter growth rather than year-over-year growth.
The fact of the matter though is that if we can continue to see positive sales growth then we should all feel pretty comfortable with the markets longer term. Companies have become much leaner since the Great Recession which should mean in theory, that the increases we see in sales should filter down in greater chunks to the bottom line numbers. This means greater value for investors and more profitability for the underlying companies.
Given the fact that the S&P 500 sales growth was actually negative (year-over-year) in Q1, the current trajectory for sales growth for this quarter seems to be a very good improvement. From this standpoint alone, we would have to conclude that this is a successful earnings season, if things continue on this path.
But despite the recent improvement in sales, we have likely seen the expectations for this improvement already built into the marketplace. The current price to sales ratio for the broad S&P 500 is 1.55, which would put it in the expensive territory when looking back to 1955.
Although price to sales is just one data point within the many to choose from, this one fundamental valuation would suggest the possibility of a slowing in the markets’ recent gains. If we were to also lump in another data point that helps to identify short term corrections, we would see that the markets are ripe for a slowdown or possible correction. Current market sentiment has come off a recent bottom (pessimistic levels) and now finds itself well within the overly optimistic levels, a sign of a possible correction.
Currently, the market is on pace to end the year up about 32% and this just doesn’t seem logical at this stage of the game and with what is on the horizon in regards to issues facing Washington.
So, despite the recent improvement in top line numbers, basic fundamental valuations suggest a market breather is on the horizon. However, this should not downplay the improved top line data as markets will ultimately applaud this over the longer term as we see the increased sales flow into improved (and sustainable) bottom line increases. In the near term though, investors seem to have expected the recent improvement and built these expectations into the prices of the securities.
(All data used within The Capital Course was provided by Ned Davis Research)