Lost amid the deluge of negative headlines about tariffs, trade wars, Syria, Russia, interest rates, technology regulation and so on has been the impressive health of the corporate sector. Earnings season, where companies report their operating results to investors, began in earnest last week. Wall Street analysts are calling for a very strong earnings season as companies stand to doubly benefit from the ongoing and increasingly broad-based global economic expansion in addition to the recently enacted tax law changes which serve to reduce companies’ overall tax burden.
Analysts are projecting that U.S. companies in aggregate will announce that their earnings over the last four quarters cumulatively grew by 18% relative to the same period a year earlier. Analysts are further forecasting that for the full year in 2018, S&P 500 companies are estimated to grow their earnings by 25% vs. 2017 as depicted in the near-by chart.
The Financial Times recently reported that companies broadly plan to distribute a significant sum of these earnings to investors via a combination of share buybacks and dividends. According to the FT, citing research from JPMorgan, “Overall U.S. companies will buy back about $800bn of their stock this year, the bank forecasts, up from $525bn in 2017, and boost dividend payouts by about 10 per cent to a record $500bn.”1
Cumulatively, according to JPMorgan’s estimates, U.S. companies will distribute approximately $1.3 trillion to shareholders in 2018. Based on the total market capitalization of U.S. stocks as of the end of the first quarter (approximately $27.3 trillion according to data from Ycharts), these distributions equate to a cumulative distribution yield of roughly 4.8%.
This is important because research has resoundingly demonstrated that over the long haul, yields (dividends plus net buybacks) and earnings growth are the two main drivers of equity market returns. Over the short-term, of course, equity markets can be and often are largely driven by swings in investor sentiment, which push stock market valuations up or down in unpredictable ways.
Jack Bogle, the founder of Vanguard, has referred to the combination of yields and earnings growth as the stock market’s “investment return” and has contrasted it to the market’s “speculative return” which, even over periods as long as a decade or more, can be either significantly positive (when sentiment is bullish and valuations are rising) or negative (when sentiment turns sour and valuations are declining), or somewhere more modestly in between. Over the long-term it’s reasonable to expect that the speculative component of returns will be effectively zero as the positive swings largely cancel out the negative ones, which is what we’ve ultimately seen empirically.
We’ll conclude this commentary by lastly highlighting that companies do not appear to be sacrificing future growth in exchange for higher shareholder distributions today—in addition to today’s sizeable distributions, companies in aggregate are investing significant sums of capital back into their businesses in hopes of driving future breakthroughs and ultimately profits. The Financial Times, citing research from Goldman Sachs, stated “U.S. companies will lift their spending on investments, research and development by 11 per cent to more than $1tn this year…”
1 “Corporate America Poised to Unveil Record Buybacks” Financial Times, April 15, 2018.
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