INSIGHTS

The fortunes of the sharemarket is influenced by a range of factors, including interest rates, investor sentiment and expectations of where the global economy is headed. However, when it comes to the crunch, company earnings are the biggest driver of where share prices go in the long-term.

In theory, a company’s share price should reflect the present value of all the future cash flows of the business. If the prospects for those earnings and cash flows improves – even if they’re some way off in the future – the share price will rise to reflect that, and vice versa.

Over the short-term, or even for long periods, share prices can become disconnected from the earnings picture, but sooner or later the value of any company comes back to the profits it is expected to generate.

The path of corporate earnings can also tell us a lot about the state of the economy. They provide a very timely reflection of current economic conditions, as well as a signpost for how the future might be shaping up. Profitable, growing businesses are much more likely to hire staff, invest and pay taxes.

For all these reasons, the corporate reporting season is a very important period for sharemarket analysts and investors. This is when companies announce results, release their latest financial statements and provide some comments on the outlook for their businesses.

For the biggest economy and sharemarket in the world, the United States, companies report on a quarterly basis. This allows us to take stock of the corporate earnings backdrop every three months and gain some valuable insights into the state of some of the world’s biggest companies.

The quarterly reporting season in the US is wrapping up as we speak and pleasingly, it has been a fairly good one, particularly considering the circumstances.

More than 90 per cent of the companies in the S&P 500, the highest profile US sharemarket index, have now announced results for the September 2020 quarter. Of these, 71 per cent have beaten revenue forecasts and 84 per cent have exceeded earnings expectations.

Aggregate earnings for the market fell 7.1 per cent compared to the same period a year earlier, although that was a much better outcome than had been expected. Before the reporting season began, analysts were predicting a 21.2 per cent decline.

Companies in the healthcare, communication services and technology sectors have performed best, with all these managing to grow their earnings compared to a year earlier. This is unsurprising, given these sectors have all seen demand for their products increase strongly through the pandemic and associated lockdowns.

Looking at the 2020 calendar year overall, the S&P 500 is expected to see corporate earnings fall by 14.5 per cent compared with 2019, before rebounding 22.1 per cent in 2021. If these forecasts prove to be accurate, 2021 aggregate earnings will be slightly above the pre-COVID levels of 2019.

Despite all the challenges we’ve experienced in 2020, shares in the US and New Zealand have performed very well and delivered excellent returns to investors.

Over the past 12 months, the S&P 500 is up 18.3 per cent, while the local NZX 50 index isn’t far behind with a gain of 17.4 per cent.

For this strength to continue into 2021, we will need to see businesses continue to recover and for this to be reflected in corporate earnings.

As the year draws to a close, it is encouraging to see profitability across many parts of the market proving much more resilient than many would’ve expected.