S&P 500 Companies Report Record Profit Margins

Lower tax rate has boosted company earnings, resulting in a record-level profit margin for the index, says expert
August 15, 2018 Updated: August 16, 2018

WASHINGTON—Profit margins of S&P 500 companies have soared to their highest level in a decade, as businesses start to see the effects of U.S. tax reform.

The blended net profit margin of companies in the index rose to 11.8 percent in the second quarter, the highest level since financial data provider FactSet began tracking the measure in 2008. It’s also the third consecutive quarter for double-digit earnings growth across the index, according to FactSet.

“The reduction in the corporate tax rate due to the new tax law is likely a significant factor, as the lower tax rate has boosted earnings for companies,” John Butters, a senior earnings analyst at FactSet, said in a report. “It appears the lower tax rate is more than offsetting the impact of rising costs, resulting in a record-level net profit margin for the index for the second quarter.”

The blended year-on-year earnings growth rate for the index in the quarter was 24.6 percent. That’s the index’s second-highest growth rate since the third quarter of 2010.

“It is interesting to note that analysts expect even higher net profit margins for the remainder of 2018,” Butters said.

In the second quarter, all sectors reported growth in earnings, while 10 of 11 sectors recorded double-digit growth, led by energy, materials, and information technology sectors. Energy companies reported the highest year-on-year earnings growth at 125 percent.

The unusually high earnings growth in the energy category was driven by a combination of factors, including high oil prices and a comparison to unusually low earnings recorded a year ago, FactSet said. The average price of oil in the second quarter was 41 percent higher than the price of oil during the same period last year.

The blended year-on-year revenue growth rate for the S&P 500 for the quarter was almost 10 percent. And the sales growth rate was 13.5 percent for the companies that generate more than half of their sales outside the United States.

Companies with more international exposure reported higher earnings and sales growth in the second quarter, overcoming concerns in the market about the impact of a rising U.S. dollar and slower global economic growth on these companies.

US Stocks Outperform Foreign Stocks

The U.S. stock market got another boost from President Donald Trump’s “America First” policies in recent months. American stocks have substantially outperformed foreign stocks since May, when the trade disputes between the United States and other trading markets began to heat up.

U.S. stocks have risen 6.4 percent year-to-date, while foreign stocks fell 6.6 percent, according to The Wall Street Journal. The robust economic and earnings growth, as well as the stability and the safety of the U.S. market, have attracted investors,  the Journal reported.

Strong earnings growth will continue at almost 20 percent through the remainder of the year, according to analysts. However, it will start to come down in the first half of 2019, they estimate.

In addition, a record level of companies surprised analysts in the quarter by reporting earnings that topped estimates.

According to FactSet, 79 percent of S&P companies reported actual earnings per share (EPS) above the mean EPS estimate by analysts, the highest since 2008. In aggregate, earnings beat expectations by 5.0 percent.

The consumer discretionary category saw the largest earnings surprise, with companies such as online retailer Amazon.com, and home construction and real estate company Lennar reporting profits of more than double what analysts expected.

“Overall, the housing market has remained strong and seems to continue to strengthen,” Stuart Miller, executive chairman of Lennar, told analysts in a conference call on June 26. “There continues to be a general sense of optimism in the market. Unemployment is at historic lows.”

On July 26, Amazon CFO Brian Olsavsky commented on the company’s strong results. He said in a conference call that the company’s high-margin businesses, like cloud computing and advertising, were significant contributors to the profit growth.

And on revenues, financial companies reported the largest positive surprise. U.S. banks, in particular, benefited from strong consumer sentiment in the quarter, reporting higher revenues than expected.

JPMorgan CEO Jamie Dimon said in a statement that “the healthy U.S. consumer” helped drive double-digit growth in the bank’s credit-card and money-management businesses.

“We see good global economic growth, particularly in the United States, where consumer and business sentiment is high,” he stated.

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