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Surprise: Companies are making bigger profits than expected

FILE - In this Wednesday, May 3, 2017, file photo, specialist Anthony Rinaldi works on the floor of the New York Stock Exchange. For all the worries about when the stock market will finally crack, one of the biggest reasons for its rise keeps chugging along. Corporate profits continue to pile higher, and companies have been lining up in recent weeks to tell investors that they made more during the summer than Wall Street had forecast. (AP Photo/Richard Drew, File)
November 09, 2017 - 7:10 AM

NEW YORK - Corporate profits keep chugging along.

Companies have lined up in recent weeks to tell investors that they earned more during the summer than Wall Street had forecast, and the big numbers offer some reassurance for the market's skeptics.

Stock prices tend to track corporate profits over the long term, so the better-than-expected growth helps to validate the stock market's record-setting run, at least somewhat. Still, this earnings season also includes some signs the eight-plus-year rally is nearer the finish than the start.

Coming into this earnings reporting season, many analysts were forecasting a dud. Insurers forced to make big payout for hurricane damage would drag earnings sharply lower for the financial sector. Lower commodity prices would pull down profits for raw-material producers.

Just ahead of earnings season, analysts were penciling in only 3.2 per cent growth in earnings per share for companies in the S&P 500. Those same companies produced a robust 11 per cent growth in earnings per share in the spring.

Then JPMorgan Chase kicked off earnings season Oct. 12 and surprised Wall Street with a better-than-expected 7 per cent rise in earnings per share thanks to growth in loans and deposits. In the weeks that followed, everyone from Apple to Zoetis followed suit.

More than 400 of the companies in the S&P 500 have reported their results for the July-through-September quarter, and they've been so much better than forecast that Wall Street has more than doubled its expectations for third-quarter earnings growth to 6.8 per cent, according to S&P Global Market Intelligence.

Analysts are notorious for underestimating corporate profits, so it's not unusual for companies to turn in better results than expected. But the rate is even higher this reporting season than typical. Through last week, 74 per cent of the companies that reported results topped analysts' expectations, according to FactSet. That's better than the average rate of 69 per cent over the last five years.

What's more encouraging to many investors is that more companies than usual are also reporting higher revenue than analysts had forecast.

Strong sales growth has been rare in recent years, a result of the generally tepid global economy. But markets stretching from the U.S. to Europe to Asia appear to be hitting a higher gear at the same time, which is feeding into higher sales. Sixty-six per cent of companies have reported better revenue for the latest quarter than expected, well above the average rate of 55 per cent over the last five years, according to FactSet.

Apple, for example, said its revenue rose a stronger-than-expected 12 per cent last quarter on gains for all its product categories, including its services division that includes its app store. Zoetis, which sells vaccines and medicines for animals, reported higher revenue than analysts expected thanks in part to particularly strong growth from outside the United States.

"They're not doing it because they repurchased a bunch of shares or whatever," Phil Orlando, chief equity market strategist at Federated Investors, said of companies across the market. "Earnings quality driven by top-line growth has been very encouraging. It's been a high-quality earnings season."

Of course, not every company is beating expectations, and the laggards have been harshly punished this reporting season. Consider Philip Morris International, the cigarette maker that reported higher profit for its latest quarter, but not as high as Wall Street had forecast. Its stock fell 3.9 per cent on the day of its report.

Across the S&P 500, companies that fell short of Wall Street's earnings forecasts have seen their stocks fall by an average of 3.6 per cent, from two days prior to the earnings release through the two days following. That's worse than the average drop of 2.4 per cent over the last five years.

This reaction — where the punishment for missing earnings expectations is much bigger than the reward for topping forecasts — is typically seen closer to the end of a bull market than the beginning of one, said Jon Mackay, investment strategist at Schroders.

"That's classic late-cycle behaviour," he said. "That indicates there's a little bit of exhaustion to markets," though he said it doesn't necessarily mean a drop in stock prices is imminent.

Analysts expect the cycle to last for at least another couple quarters. They're forecasting earnings growth for S&P 500 companies to accelerate to 10 per cent in the current quarter and remain there in early 2018, according to FactSet. That is, if they don't underestimate yet again.

News from © The Associated Press, 2017
The Associated Press

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