Corporate profits

Beautiful corporate earnings growth may not be as strong as it seems

An image from the financial crisis comedy-drama The Big Short. Analysts point to cost pressures undermining seemingly good corporate earnings. Photo / Jaap Buitendijk

Wall Street’s strong gains this summer have spread widely across all sectors. Is earnings growth helping to sustain these gains? Not really.

About 90% of S&P 500 companies have reported second-quarter results, and their earnings per share are nearly 8% above year-ago levels overall.

Along with market hopes that inflation could be close to a peak, this strong growth has helped the benchmark index jump about 15% since mid-June. A closer look shows that investors are driving up prices on all stocks, not just those that generate big profits.

Energy companies including Exxon Mobil and Chevron saw profits nearly quadruple in the last quarter from a year earlier as oil, gasoline and natural gas prices soared amid the worst inflation in 40 years.

Take out those companies and earnings actually fell for the S&P 500, according to FactSet data.

Still, these non-energy stocks rose 9.1% from late June through Tuesday, slightly better than the 8.9% gain for the index as a whole.

Business revenues continue to rise as they charge higher prices for their products and a strong job market keeps many customers buying.

But for many companies, their costs are rising even faster than their revenues, reducing their profitability.

While companies are still making very high profits on every dollar of revenue relative to history, their profit margins have fallen a bit recently.

This could get worse if inflation is really close to peaking and companies start to reverse their own price hikes.

The trend is clear when looking at the inflation gap between the prices companies pay at the wholesale level and what companies charge at the consumer level, according to Morgan Stanley strategists led by Michael Wilson .

Wholesale inflation has never been higher than consumer price inflation, which “causes problems for margins in the coming quarters,” Wilson wrote in a recent report.

“The bottom line is that earnings estimates remain too high in our view whether we’re in a recession or not,” he said.

-By Stan Choe