Preparing for 2nd Quarter Earnings Reports
Next week the 2nd quarter earnings reporting season will begin, starting with Alcoa on Monday. As shown in the graph below (click graph to enlarge), a record number of companies in the S&P 500 index have issued negative guidance for the quarter. This is not necessarily a bad thing to the extent that it is not uncommon for companies to issue negative guidance and then outperform the lower guidance. It is important to point out that the level of expected underperformance versus guidance is below the historical averages. This means that although companies are reporting negative guidance for the quarter, the earning shouldn’t be too far below expectations. It is also the case that the financial sector, which is a bell weather sector for the overall economy, is showing a great deal of strength in the pre-earning announcements for the quarter.
Source: Factset
As shown below, earnings per share for companies in the S&P 500 index in the 1st quarter were above the peak levels seen in 2007. For the 2nd quarter, earnings per share are expected to be higher than the last quarter.
Source: J.P. Morgan
One area driving this strength in earnings is increasing profit margins. The increased margins are occurring because of strong costs cutting measures that companies have undertaken since the recession. But as the graph below illustrates, there has been a trend of improving profit margins over the past 25 years as our economy has evolved from one based on manufacturing to one based on technology, information and dramatic increases in productivity. In order for earning to continue to increase, companies will need to see revenues increase since we will probably start to see profit margins decrease as companies expand and labor markets become tighter.
Source: J. P. Morgan