One word describes the bottom line on the bottom line for second-quarter earnings season, and the top line, and the middle lines for that matter: down. With about 93% of the S&P 500 companies having reported results, profit growth was down in the second quarter, for the third straight quarter. Sales fell, too. So did operating margins.
When the final 10% chimes in, S&P 500 profits for the second quarter are expected to be about $22.85 a share, going by standard accounting, down an unsightly 15.8% from the second quarter of 2014, according to data from S&P Dow Jones Indices. It’s the first outright decline since the third quarter of 2012.
Wait, what? 16%? Yes. How is that possible, you ask?
It’s all about what gets excluded and included when the numbers get compiled. S&P’s numbers are based on generally accepted accounting principles. That means all expenses get counted. Stock-based compensation expenses get counted. Pension expenses get counted. S&P also calculates an operating earnings figure, which excludes some of the costs the companies themselves exclude, one-time items like write-offs. That measure has earnings contracting a narrower 10.6%.
Thomson Reuters, by contrast, reports second-quarter earnings growing 1.2%. Nothing great, but not negative, and this is the number the Street follows the closest. Thomson gets its numbers from Wall Street analysts, who tend to exclude the costs the companies themselves exclude, like stock-based compensation expenses. There is a long-standing debate about the merits of including or excluding those costs. One thing is certain, though: those costs are not minor. As the Journal reported back in May, the difference between GAAP and “pro-forma” figures, most prominently among tech companies, is wide (and given that the tech sector makes one of the biggest contributions to profit growth, the gap – if you’ll excuse the pun – is weighty).
Those costs aren’t the only or even main reason for the drop in profit growth, however. The real proximate cause for this is the plunging energy sector, where sales fell 33% from a year ago, and profits plunged. The sector got hammered in the quarter, especially since the comparison was to last summer when prices hit a multi-year high. Chevron Corp. posted its worst quarterly profit since 2002. Exxon Mobil Corp. posted its worst numbers in six years, as its earnings were cut in half by the crash in oil prices. If you strip energy out of the S&P calculations, profit growth in the second-quarter would be flat, according to S&P’s senior index analyst, Howard Silverblatt.
The slide in profit growth isn’t going to stop with the second-quarter figures. Third quarter earnings are expected to continue the downtrend, off 2% from the year-ago quarter (which was, to be fair, a record high, $27.47 a share). Excluding the projected 64% drop in energy profits, that would become a 5% profit growth, according to Mr. Silverblatt.
Profit margins are down too. Operating margins peaked in the third quarter of 2014, at 10.10%. They are seen coming in at 9.31% in the second quarter, down about 7.6% from that peak.
Profit growth, sales, and margins weren’t the only things to fall, either. The other thing that fell were share counts. Fully 65% of the companies that have reported earnings had fewer shares outstanding this quarter than a year ago, and about 20% of them saw shares outstanding fall by at least 4%, “therefore adding at least a 4% tailwind to their current EPS,” Mr. Silverblatt noted.
One thing that is rising is the P/E ratio. With earnings down, the index’s PE is up to 22.15, according to S&P. Based on current earnings estimates and the current level of the S&P 500, it’s projected (a moving target to be sure, given volatility these days) to rise to 22.25 in the current, third quarter, based on GAAP figures, before starting to ease off. If all goes well, it will be down to 17.12 by the end of 2016.
There is one other line that increased, which will almost certainly make shareholders happy. Cash dividends per share were $10.69, and that is fresh record. Call it a silver line, if you like.