A Wall Street Journal Report today by Kate Linebaugh and James Hagerty, Business Abroad Drives U.S. Profits, points to way foreign operations of leading US corporations have contributed to the very satisfactory second quarter earnings season now well under way in New York. One third through the earnings reporting season for the S&P 500 companies, earnings are the highest they have been in four years.
These S&P 500 earnings per share may well exceed $100 for the 2011 calendar year. The drivers for this earnings growth however, as the report points out, is not the struggling US economy, but the off shore operations of these companies.
About three quarters of the companies that have reported so far have done better than analysts expected. As the WSJ report states, “…Many of them – ranging from manufacturers Honeywell International Inc. and Caterpillar Inc. to drug maker Abbott Laboratories – raised their earnings forecasts for later in the year.
The report refers to the bellwether industrial giant GE that reported a 21% increase in earnings to $3.8bn for the second quarter. Yet US revenues in GE’s core industrial businesses shrank about 3.4% while international industrial revenue soared 23% to $13.4bn, accounting for about 59% of the company’s total industrial revenue. This translates into growth in capital expenditure and employment offshore rather than on US shores making the US economic recovery less likely to benefit from the financial strength of US corporations, many of whom have a strong global footprint.
We have been firmly of the view that the most compelling way to gain exposure to the global economy is via the companies listed on the S&P 500. The valuations of these companies appeared very undemanding of earnings growth, trading as they do well below their average price to trailing earnings multiples (which averaged as much as 21 times between 1980 and 2011). The current trailing S&P 500 earnings per share, calculated before higher second quarter earnings have been reported, is US$81.31. This puts the S&P on a trailing 16.5x earnings and a prospective forward PE of under 14 times earnings to be reported in the first quarter of 2012.
This advice has proven apposite as we show below. Since 1 January 2011, the S&P 500 has gained almost 7% (to 23 July) while the MSCI EM is flat and the JSE in US dollars is 2.5% weaker than on 1 January 2011.
However as we also show, S&P earnings year to date have significantly outpaced the share market index, adding to the case for investing in the S&P 500. We remain firmly of the view that the S&P 500 is still very undemanding of future earnings growth and even less demanding than it was. And the unsatisfactory state of the US economy can be expected to continue to keep down interest rates in the US (and so the competition for equities from fixed interest income)
To view the graphs and tables referred to in the article, see Daily Ideas in the Daily View: Daily View 25 July