Corporate profits

Fear surrounding corporate earnings is exaggerated

Goldman Sachs says investors are increasingly wary of tight corporate profit margins.

Company response: Don’t worry.

The measure in question is National Income and Product Accounts (NIPA) profit margin – a data calculated by the government which fell to 10.6% in the first quarter of 2017, against 12.3% two years earlier.

Goldman says this has caught traders’ attention and made some skeptical of what has always been the main driver of stock market gains: earnings growth. But the data isn’t as bad as it looks on closer examination.

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S&P 500 margins look more robust than those of their NIPA peers.

Goldman Sachs

First and foremost, the NIPA figure includes private companies in addition to their public counterparts. It also measures smaller companies, which tend to be less profitable and have no effect on major stock indexes, Goldman says.

The company also points out that NIPA earnings are more heavily skewed towards sectors such as legal and medical services, away from the high-margin tech companies that rule the world. S&P500 and dictate so many vast exchanges.

“Underlying profitability in US corporate stocks appears healthy,” wrote a group of Goldman strategists led by David Kostin in a client note. “We expect S&P 500 profit margins to be roughly flat through 2018.”

For Goldman, the S&P 500’s return on equity (ROE) is a better indicator of profitability — and it appears to be in good shape. The measure improved for a third consecutive period in the first quarter, reaching 14.9%.

Another measure of corporate earnings — simple year-over-year earnings growth — is showing signs of strength. The S&P 500 is expected to increase earnings by 7.3% in the second quarter, which would mark its fourth consecutive period of expansion, according to data compiled by Bloomberg.