Company Profits May Soar on a Tail Wind From Abroad
Will a weak dollar and global growth stump Wall Street again?
Though the economy is catching a second wind, corporate profits aren't—at least not according to Wall Street.
In fact, many analysts think that earnings growth for companies in the Standard & Poor's 500 index slowed dramatically in the just ended second quarter.
Yet there's good reason to think the analysts have it wrong—again—and that profits are doing just fine. That would certainly give the stock market bulls even more tasty fodder to feed on.
Right now, the Wall Street consensus is that S&P 500 earnings grew a modest 4.3 percent from April through June, versus the same period a year ago, according to Thomson Financial. This would be a huge letdown for corporate profits. After all, earnings expanded by nearly 8 percent in the first quarter and grew by double digits in the 14 quarters before that.
But keep in mind that Wall Street analysts were similarly pessimistic about first-quarter earnings growth three months ago, projecting that corporate profits would grow by as little as 3 percent.
They misfired on two fronts: underestimating both how the weak dollar would boost the value of U.S.-based multinationals' profits generated overseas and the impact of foreign sales in a hot global economy.
Well, those same analysts may be making the same mistakes again.
Growth engine. Consider that more than 45 percent of S&P 500 companies' revenues now come from outside the United States. That's up from less than a third in 2001. And the global economy is easily outpacing U.S. growth, says Alec Young, international equity strategist for Standard & Poor's.
Meanwhile, corporate profits are expected to grow at 10.3 percent this year outside the United States, versus 7.3 percent domestically. With the dollar still weak, that should pump up U.S. multinationals' foreign earnings.
The bottom line: Corporate profits are likely to "surprise to the upside," as Wall Streeters say. "I don't want to call it a cakewalk, but companies should be able to beat the current estimate," says Jack Ablin, chief investment officer for Harris Private Bank.
Mike Thompson, managing director of global research at Thomson Financial, predicts that "second-quarter profits could end up shaking out somewhere north of 7 percent." That would put earnings growth in line with the historic annual gain of roughly 7 percent, he says.
So, are U.S. stocks still a buy? Thompson thinks so. And Jeffrey Kleintop, chief market strategist for LPL Financial Services, sees the S&P 500 advancing 5 percent more this year, on top of the 7 percent gain it notched in the first half of 2007.
If corporate profits prove much stronger than expected, Kleintop says, stocks could climb even more, since the market has been unusually sensitive to earnings results in the past couple of years. In other words, if Wall Street keeps seeing the corporate earnings glass as being half empty—and if the profits keep pouring on—your investment cup could soon be running over with gains.
This story appears in the July 16, 2007 print edition of U.S. News & World Report.
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