Profit-Growth Rate Depends On Where You Look

10/23/2017


Most of the noninvestors I know (as well as many investors) see Wall Street as a fantasyland, a place where the rules that govern the rest of the country don't apply.

I can't fault that viewpoint too much. Fantasyland seems like a good name for a place where firms can write off massive court judgements as special items and not count them against "core" earnings. Sometimes the disparity between Wall Street and Main Street results suggests pixie dust may be involved. For example:

In 1991, U.S. corporate profits as calculated by the U.S. Bureau of Economic Analysis rose about 8%, while the S&P 500 Index's per-share profits fell 15%. Nine years later, in 2000, overall corporate profits declined about 6%, while the index managed 9% profit growth. In contrast, in every year from 2002 through 2005, both measures of profit were within three percentage points of each other.

Don't write off the divergence as old news — every year from 2008 through 2012, growth rates for the S&P 500 and U.S. corporate profits differed by at least nine percentage points, and twice by more than 20%.

We can blame the variations in profit growth mostly on differences between how companies compute their profits and how the Bureau of Economic Analysis derives overall corporate profits. The BEA's "profits from current production" excludes capital gains and dividend income, as well as some types of expense deductions that corporations use to boost their after-tax numbers. Share buybacks have also boosted S&P 500 profits about 1% a year over the last quarter century. Still, when you give the stock market enough time, it can boil away the hype and disparities, revealing the naked results of U.S. businesses.

Since the start of 1988, U.S. corporate profits have averaged a growth rate of 7.0%, slightly higher than the 6.4% they managed in the second quarter. The S&P 500 Index has averaged 7.3% quarterly per-share-profit growth over the same period. Year-to-year differences aside, the similar growth rates over the last 28-plus years illustrate the index's value as a broad-market proxy.

That's why we don't worry too much about the near-term divergence in estimates.

The Blue Chip Economic Indicators consensus projects 4.4% growth for U.S. corporate profits this year and 4.5% in 2018, a solid recovery from declines in 2016 and 2015 but still below the long-run growth rate. In contrast, Thomson Reuters expects the S&P 500 Index to post per-share-profit growth of at least 11% this year and next year.

The disparity between expectations for overall corporate profits and S&P 500 earnings isn't as big a deal as it might seem because of the statistics' long history of divergence.

Of course, stock analysts tend to be overly optimistic, and their projections of double-digit growth may not come to fruition. But I find it encouraging that both the stock analysts who project earnings for S&P 500 companies and the economists who assess broad profit trends expect good things over the next year or so.


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