Pit Stop

Second-quarter earnings season is fast coming round the bend, with companies due to update investors on their track record over the past three months – and analysts keen to kick the tires on firms’ fresh forecasts.

 

🕰 Recap

  • Back in April, analysts were expecting US companies to grow their first-quarter earnings 25% compared to a year ago – the most in a decade.
  • But companies ended up delivering roughly double that growth, with consumer discretionary and financial firms at the forefront.
  • Analysts are now predicting US companies will report second-quarter profits 63% higher than the same time last year.

 

✍️ Connecting The Dots

Every quarter, America’s public companies pull back the curtain on how they’ve performed in the last three months. Management might take the opportunity to talk up the firm’s achievements: product launches, new store openings, and the like. But investors are far more interested in revenue and profit – and finding out whether their previous forecasts (as well as decisions to buy or sell) have been vindicated.

According to data provider FactSet, analysts currently predict that the average profit at companies in the US S&P 500 index will come in 63% higher than this time last year. That’d make for the biggest increase since 2009, eclipsing even the first quarter’s impressive earnings growth. But the reason for this optimism’s pretty obvious: the US economy is recovering from the effects of coronavirus far faster than first expected.

That’s particularly noticeable in a few key sectors. Industrial firms, for instance, are notoriously cyclical – they see their highest earnings growth when the economy’s on the up. Analysts are therefore expecting industrial companies to post average earnings growth of 350% versus the same time last year. The average bank, meanwhile, is forecast to post profit growth more than twice as large as in the second quarter of 2020. Even though trading revenue will have dropped, company merger activity – which is on track for a record year – should bring with it a ton of fees that’ll add more to profits than reduced trading takes away.

 

🥡 Takeaways

1. Earnings are coming home, but they’ve been expected.

Analysts’ average year-end targets for the S&P 500 have risen from 4,000 at the start of 2021 to 4,300 today as the index has ground ever higher. This rally can’t last forever, mind you: the pace of US economic expansion is expected to slow from 6.6% this year to just 2.3% in 2023, and that’ll eventually rein in company profit growth. That should in turn see investors selling off those shares that’ve risen the most and which therefore look expensive relative to their earnings – moving instead into assets with more attractive risk-reward ratios.

2. The things you don’t know will make or break your earnings season.

Earnings expectations for the next few years are by and large already reflected in stock prices, so hurriedly buying into companies now on the basis of their anticipated performance next quarter probably won’t net you much of a return. That said, if a company (or indeed an entire industry) significantly surprises either way with its earnings or outlook, you’ll see share prices quickly adjust to match the new data. If you’ve got a strong view about that, then putting it into action could be worth a punt. Just remember, though, that stocks don’t always respond to news in the way you might think.

 

🎯 Also On Our Radar

Late last week, Melvin Capital revealed it’d turned in a -46% investment performance in the first half of 2021. The hedge fund had made big bets against the likes of GameStop and AMC Entertainment and got burned when retail investors seemingly conspired to send these heavily shorted stocks “to the moon” earlier this year. Melvin Capital said it’d changed the way it invests as a result. Never let it be said that retail investors don’t have any influence over the pros…

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