Earnings at big public companies haven't been growing all that much lately. Which isn't to say that companies haven't been extremely profitable.
Earnings season is getting under way, and results for the final quarter of last year look to be underwhelming. Analysts' latest estimates are for earnings per share for members of the S&P 500 to have shrunk by 2.2% in the fourth quarter from a year earlier -- a figure that is flattered by an expected 65% gain in energy-sector earnings. Exclude those, and analysts estimate earnings fell by 6.7%.
Actual results likely won't be quite so bad, since by the time companies start reporting analysts have typically lowered estimates to the point that most companies easily exceed them. But they will probably still count as a deep disappointment based on where expectations stood a year ago, when analysts thought that fourth-quarter 2022 S&P 500 earnings would register a 14.3% gain.
Two things hit companies at once in the past year. First, sales growth weakened as economies around the world struggled. Second, costs rose faster than sales, cutting into bottom lines. S&P Dow Jones Indices estimates that S&P 500 operating margins fell to 12.1% in the fourth quarter from 13.4% a year earlier. But 12.1% is still very high: In the prepandemic fourth quarter of 2019, S&P 500 operating margins stood at 10.6%.
This is a reflection of how much margins benefited from the Covid crisis: Sales, buoyed by heady demand and the higher prices that companies were able to charge, ran ahead of costs. Remarkably, analysts expect profit margins to widen again, with Refinitiv showing that they expect S&P 500 earnings will be 10.9% higher in the fourth quarter of 2023 from a year earlier, versus sales growth of just 3.9%.
Yet it seems more likely that profit margins will narrow in the year ahead. At the very least, one might expect them to slip back to where they were before the pandemic as the economy continues to normalize. That on its own could drag S&P 500 earnings down by over 10% relative to where they would be if margins held steady.
The recession that many economists are forecasting this year could make the profit picture even worse, since in downturns companies' sales typically deteriorate more quickly than they can lower their costs. Over the past 75 years, corporate profits as a share of gross domestic product -- a proxy for profit margins -- have slipped during nearly every recession.
The best outcome for earnings probably would be for both the U.S. and overseas economies to start growing at faster clips, generating the sales growth companies need to more easily absorb costs. With the Federal Reserve and other central banks still raising interest rates, however, a rebound in profit growth looks less like a story for 2023 than one for 2024.