US companies are taking the Q3 earnings season by storm

It would be no exaggeration to say that US companies have once again proven they are downright excellent at generating sustainable profits.

Despite challenging macroeconomic conditions and all sorts of expectations, 2023 looks set to be a year where profit growth stands out across the S&P 500. Moreover, if Wall Street analysts are right, 2024 will be an even better year.

The earnings season is almost over, and frankly, corporate performance has not looked bad at all so far. 82% of the companies in the index that have reported earnings have exceeded expectations, surpassing the five-year average of 77%. 

Furthermore, despite many expecting a collapse in earnings, analysts predict that US companies will see a 1% increase in profitability throughout 2023. 

A large portion of the companies listed on the S&P 500 have increased their profits this year; eight out of 11 sectors have grown their profits and have also outperformed the index so far. 

When we take a closer look at the details of the companies operating in these sectors, we can see that a few mega-cap companies are supporting the overall performance. 

For instance, in the communication and consumer discretionary sectors, the growth of around 40% seen in these areas can be largely attributed to Meta Platforms (META) in communication and Amazon (AMZN) in consumer discretionary.

When we exclude these two giants from the calculation, the earnings growth rate drops to 29% in communication and 23% in consumer discretionary. Admittedly, these rates are not bad at all either. 

Of course, we must not forget technology. The sector's 11% profit growth is good, but it is hard to say that it fully explains the overall growth of the index.

Today's so-called 'Magnificent Seven,' consisting of Alphabet, Apple, Microsoft, Meta Platforms, Nvidia, and Tesla, may be responsible for a large portion of the US stock market's gains this year. 

But the real strength in other areas of the market extends beyond these leaders; looking at it from another perspective, while the stocks of these market leaders have risen in parallel with their fundamental performance (and in some cases even more), other stocks have not risen much. This means that the valuations of smaller technology companies are actually contracting. However, the sector's profit growth remains quite strong. 

On the other hand, revenues may have grown by 2.3% in the third quarter, but this is below profit growth. This means only one thing: wider profit margins. 

When we look at the sectors, margins only truly contracted in the materials, healthcare, and energy sectors, meaning profit either grew slower than revenue or declined faster. In the materials and energy sectors, revenues tended to decline along with falling commodity prices, which is exactly what happened. 

WHAT IS NEXT?

It would be an exaggeration to say that US companies have been rowing against the tide this year, as the seemingly inevitable recession has not yet materialized. However, it has still been a worrying year for the stock markets and companies. 

Usually, when problems appear on the horizon, companies tend to act quickly to streamline operations, increase efficiency, and reduce burdens where they can. Once the storm has passed (or perhaps changed direction), revenues begin to accumulate on a lower cost base. 

And if some of the cut expenses were fixed costs (meaning they were not tied to sales growth), these would become permanent cost savings, and new revenues would translate into even more profit. So think of it this way: the margin improvements companies have achieved this year will likely spill over into next year and the year after. This is a very good thing for future growth. 

Looking ahead, we have seen that analysts now believe 2023 will be a year of surprising, albeit modest, profit growth. With less than three months to go, the probability of this forecast being correct is quite high. And next year, things could get even more interesting.

If analysts turn out to be right, this 12% earnings growth will be one of the fastest growth rates in the last decade. Only in 2018 was faster growth seen, but in saying this, we are ignoring the rebound in 2021 following the earnings stagnation of the COVID era.

This expectation is incredible, especially when you consider that interest rates are higher, global trade conditions are more challenging, and two wars are ongoing.

News Source: 12punto