Improving Earnings Will Push Stock Prices Higher

(Note: The author of this fundamental analysis is a financial writer and portfolio manager.)

The stock market closed out a rough week on March 23 with the S&P 500 Index down by nearly 6%, the worst five-day run in almost two years. But despite the decline, the picture for earnings in the S&P 500 hasn't deteriorated. Earnings growth has improved since the beginning of the year and it will likely carry stocks higher over the longer term. (For more, see also: E*Trade: March Off to a Down Start for Stocks.)

According to data from Dow Jones S&P Indices, operating earnings for 2018 have climbed by over 7.8% since Dec. 29, and by more than 7% for 2019, through March 22. Because those estimates have increased, the 2018 operating PE multiple for the S&P 500 has fallen by more than 9.5%, despite the index losing 3% so far this year.

Strong Earnings Growth

Earnings growth has always been the most significant driver for the rise of the stock market, and for now that earnings growth looks relatively healthy for 2018 and 2019. In fact, 2018 operating earnings are expected to climb by 25.3% in 2018, to $156.06 per share, and another 10.5% in 2019 to $172.49 a share. With the earnings outlook still solid, it is unlikely that over the long term the stock market will continue to struggle as it has since early February. 

S&P 500 Earnings Per Share TTM data by YCharts

Declining Earnings Multiple

With that healthy outlook for earnings growth, the 2019 operating PE ratio has dropped by over 10% to just 15.01 from 16.71 on Dec. 29. The lower earnings multiple is a combination of the S&P 500 falling by 3%, and operating earnings estimates for 2019 being lifted by 7.8% to $172.49 from $160.03. (For related reading, see: Why Stock Market's March Gains May Be Year's Best.)

S&P 500 Operating P/E Ratio Forward Estimate data by YCharts

Not Just Earnings

It is not only earnings that have grown, but S&P 500 sales per share also increased in the fourth quarter to $329.57, up nearly 7% from the third quarter's $308.22, and nearly 10% from $301.12 a year ago. Even operating margins for the index improved in the fourth quarter, to 10.27%, up from 10.16% in the third quarter. It indicates that earnings growth has come on improving sales and operational efficiencies. 

The U.S. economy continues to expand as well, with the latest Federal Reserve Bank of Atlanta's GDPNow reading tracking the first quarter of 2018 at 1.8%. That's not terrific growth but also far from recessionary. 

Barring an intense escalation of trade wars or an unforeseen geopolitical or economic event, it will be earnings growth that continues to push the stock market higher over the longer term. For now, the outlook for earnings growth continues to look strong.

Michael Kramer is the Founder of Mott Capital Management LLC, a registered investment adviser, and the manager of the company's actively managed, long-only Thematic Growth Portfolio. Kramer typically buys and holds stocks for a duration of three to five years. Click here for Kramer's bio and his portfolio's holdings. Information presented is for educational purposes only and does not intend to make an offer or solicitation for the sale or purchase of any specific securities, investments, or investment strategies. Investments involve risk and unless otherwise stated, are not guaranteed. Be sure to first consult with a qualified financial adviser and/or tax professional before implementing any strategy discussed herein. Upon request, the advisor will provide a list of all recommendations made during the past twelve months. Past performance is not indicative of future performance.