Monday, May 21, 2018

Economics: Why Wall Street Underestimates The Strong Company Earnings Growth

 

(Drivebycuriosity) - US Companies had a stellar earnings season. In the first quarter of 2018 earnings for the big US companies, which are represented in the SP 500, grew about 25% from the same period last year - and 78% beat the  earnings estimates of the analysts (nasdaq). But the US stock market ignored the rising profits and has been stagnating in the recent months. Apparently Wall Street cares more about climbing interest rates & Trump`s trade war against China and underestimates the strength of the earnings growth (zacks).

I think this is a big mistake. I assume that the strong earnings growth will continue in the coming quarters and will restart the rally on the stock market. A part of the earnings growth is the result of the recent tax cuts of the Trump administration, about 7 percentage points estimates LPL research, which reduces the (basic) earnings growth rate to about 18%. I think that company earnings will continue to grow with double-digit rates because fast rising company earnings are a long term trend.

Corporations are getting more efficient & more productive over time - thanks to learning processes and the technological progress. Companies are learning organisms because they are managed by humans who are continuously improving themselves and their companies. During the recession 2008 companies had restructured and reduced costs significantly in order to survive. Now they are more fit & more efficient than before.

Company earnings are also boosted by automation.  Since the early 18th century (the first industrial revolution) the technological process has been enabling companies to produce more goods & services with the same amount of employees. More and better machines are doing the work of people which translates into lower costs, higher profit margins and climbing earnings.

It seems that this process is accelerating again and we are at the begin of new industrial revolution. We are experiencing a rapid advance of information technology, meaning combinations of computers, smartphones, Internet and other digital systems. Software - which is increasingly Internet connected and uses more and more the cloud (access to huge external data centers) - organizes the whole business: Creating new products, inducing machines to run more efficient, finding cheap suppliers, manage customer relations and so on. Car producers and many other manufacturers are increasingly using robots and similar machines to reduce their costs. Companies are also beginning to use 3D-printers to become more cost efficient and flexible.

Company profits are also boosted by the rise of the emerging markets. China, India & Co. create additional markets. Therefore companies can produce more which translates into shrinking average production costs (economies of scale). Emerging markets also deliver cheap supplies (most computers, tablets & smartphones are manufactured there) which reduces the production costs further.

I believe that the learning process will continue and will translate into a long term trend of fast rising company profits, the engine of the stock market rally. And history shows that stock prices & interest rates can happily rise together: The Bank of America Merrill Lynch (finance) notices that “the 1950s was a period of higher stock prices and higher US interest rates. The US 10-year yield bottomed near 1.5% in late 1945 and the S&P 500 remained firmly within its secular bull market until yields moved to 5-6% in the mid 1960s. The S&P 500 rallied 460% over this period.”

Enjoy!

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