Macroscope | US company shares rally, but revenue flat and earnings seen slipping

As US company earnings rise and major stock market indices hit new heights, two small problems remain: revenues are static and the trajectory of earnings growth is slipping.

The tech-heavy Nasdaq closed Thursday at 5,056, its first close above its previous record high since March 2000, while the S&P 500 briefly topped its previous record high set last month only to close five points shy at almost 2,113. Both got a boost from ongoing reports on first-quarter earnings, which have risen despite facing headwinds from dollar strength and weakness in the energy sector.

Earnings are up at a 9.1 per cent year-on-year clip among the 40 per cent or so of S&P 500 companies to report through Thursday morning, according to data from Zacks, but with zero aggregate growth in revenues. More than two-thirds of those reporting beat expectations. All on zero revenue growth.

But how? After all, earnings have to come out of revenues, and though efficiencies can help, there is a limit.

The answer, of course, is buybacks. US companies have been on a binge, buying back US$553 billion of their own shares last year and on course to beat that easily this year. Overall US earnings growth has been boosted by 2.3 percentage points by buybacks alone, according to data from Societe Generale.

Indeed, if you look at earnings as an accountant would, meaning under generally accepted accounting principles (GAAP), then US earnings are actually in decline, and are back to about where they were in 2010.

Pro-forma earnings, the basis on which companies report, allows them to ’look through’ writedowns and one-off items. So, financial engineering, and remember a lot of those buybacks are needed just to offset the shares handed out to executives, and ’one-offs’ can give an unrealistic view of a company’s performance, not to mention its future prospects for growth.