Key takeaways

  • In a slow-growth economy, U.S. corporations reported lower second-quarter 2023 earnings compared to a year ago.

  • Analysts, however, were generally pleased that the results exceeded expectations.

  • The earnings picture looks more favorable in the second half of 2023 and into 2024.

Corporate earnings reports offered a mixed set of results for investors in the first half of the year. While profit growth slowed compared to the prior year, the decline was more modest than many market analysts anticipated.

Stock prices move up and down for a variety of reasons, but over the long term, no factor may be more important than corporate earnings. Earnings represent a corporation’s net profits and are of great interest to investors and analysts as they assess the financial health of a company and the potential of a stock’s performance. Earnings expectations often help drive the direction of the broader stock market.

As important as earnings are to the calculation of a stock’s value, it is far from the only factor that comes into play. “If all you had to consider was current earnings, expected earnings and how inflation affects those numbers, it would be simple to judge a stock or the outlook for the markets,” says Rob Haworth, senior investment strategy director at U.S. Bank. After all, the financial health of a company – as reflected by earnings – represents the most fundamental consideration in valuing equities. “But at times, as was the case in 2022, other factors overshadow earnings and may have an outsized impact on stock prices,” notes Haworth.

Stocks are performing well in 2023. Markets rebounded after a combination of higher inflation and interest rates led to 2022's bear market in stocks as well as a notable bond market downturn. With inflation receding and the Federal Reserve (Fed) possibly close to ending a period of notable interest rate hikes, earnings results are back in the spotlight.

Maintaining strong financial performance in a challenging environment

The U.S. economy expanded by 2.1% as measured by Gross Domestic Product (GDP) in 2022, a considerably slower pace than the prior year’s 5.9% growth rate. Expansion in 2023 looks much as it did in 2022 with first quarter GDP growth measuring 2.0% on an annualized basis and second quarter growth at 2.1%.1 Second quarter 2023 S&P 500 earnings declined by about 4.1% compared to results from a year earlier, according to a recent report from the investment data analysis firm FactSet. Despite the earnings decline, “The results generally came in better than many anticipated,” says Haworth.

Source: FactSet, “Earnings Insight,” September 8, 2023.

As shown above, earnings are expected to improve in the second half of the year. Based on analysts’ estimates as of September 2023, “for all of 2023, S&P 500 earnings are projected to come in at $221/share, improving to $247/share in 2024,” says Haworth. Yet he notes that some challenges remain given the economy’s modest growth rate, persistent inflation and elevated interest rates. “Earnings projections still reflect the likelihood of slower economic growth and an inability of companies to pass on the full extent of cost increases to their customers,” says Haworth. “Another potential issue is the higher cost of borrowing given today’s higher interest rates.” He is watching if many companies need to refinance existing debt at today’s higher rates, which could further dampen earnings expectations.

However, Haworth also notes that if a recession is avoided, it may mean that earnings expectations were too pessimistic, and favorable earnings surprises could result. Often when that occurs, the stock market reacts positively.

Role of earnings in stock valuation

The publicly traded companies represented as stock holdings in your portfolio deliver quarterly financial statements that include a wide range of information. This includes a breakdown of sales (revenue) and expenses, the two key factors that determine earnings. Earnings represent a company’s after-tax net income, or profits.

Earnings information is important because it provides a glimpse into the company’s business success in recent months. In many cases, companies provide “guidance” regarding their future earnings and growth prospects. This guidance serves as a preview of what may come based on trends companies experience in their businesses. While corporations often provide earnings guidance, it’s not a requirement. According to FactSet, as of September 8, 2023, 73 S&P 500 companies provided “negative” third quarter 2023 earnings guidance, a signal to investors that earnings for the quarter may be less than initially expected. By contrast, 42 companies provided “positive” guidance, indicating they anticipate better-than-expected quarterly earnings results.2 This only represents projections from companies. More telling will be when actual results become available. “Many companies are hesitant to provide forward guidance as they are waiting to see how the Fed manages interest rates going forward,” says Haworth.

“Expectations for S&P 500 earnings over the course of 2023 have declined to $218 per share today, compared to a projection of $250 per share in the middle of 2022.”

Rob Haworth, senior investment strategy director at U.S. Bank Wealth Management

Professional stock analysts often estimate, in advance, their own expectations for what companies will report each quarter. “Investors are very attuned to the forward-view of earnings, which reflects the stock market as a discounting mechanism,” says Haworth. In other words, stock prices are based less on a company’s past performance and more on expectations of future financial success. “Stock prices typically incorporate a consensus market belief about the future state of a company, including earnings, growth prospects, risks, pricing challenges and other factors,” says Haworth.

How to value a company’s stock

Earnings provide the basis of one of the major measures of a stock’s individual value. Investors often use a statistic known as the Price-to-Earnings (P/E) ratio to help assess how expensive a stock is relative to the rest of the market. In other words, it is the ratio of the current price of a stock compared to the company’s earnings. If a stock is trading at $30 per share and the company’s annual earnings are $2/share, the P/E ratio is 15.

P/E ratios are often expressed in two ways, trailing and forward. Trailing P/E reflects how the current stock price measures up against earnings over the previous 12 months. For example, in mid-September 2023, the P/E ratio for one of largest stocks in the U.S. market, Microsoft Corporation (MSFT), was 34.72. That reflected its current share price in relation to earnings generated over the previous 12 months. A second way to assess valuation is by looking at P/E ratios reflecting anticipated (forward) earnings over the next 12 months. On that basis, the P/E ratio for Microsoft stock is slightly lower, at 30.30.3 P/E ratios are generally expected to be lower when based on forward earnings rather than on trailing earnings, as companies typically are expected to be increasingly profitable over time.

Haworth notes that P/E ratio is just one measure of a stock’s performance. “We look at a variety of valuation assessments, including sales growth and book value growth, which is essentially a way of estimating the liquidation value of a company.” Other factors would include a company’s cash flow and a stock’s dividend yield.

When trying to assess which of two stocks offer the best investment opportunity based on their P/E ratios, it’s important to recognize that it’s not always an “apples-to-apples” comparison. “There can be variations in the expectations for different kinds of stocks,” says Haworth. “Determining fair value has a lot to do with the underlying growth rate of the industry in which the company competes.” Some stocks may be viewed with a longer lens, as investors demonstrate a willingness to bid up prices based not on current earnings, but on expectations of future profitability. “This tends to be the case, for example, with stocks that invest in new technology that may not have an immediate payoff but offer the potential of future strong earnings if they succeed,” says Haworth. “Other stocks may have lower P/E multiples, but those companies generate steadier earnings, so the payoff on the investment needs to happen in a more compressed timeframe.”

Factors affecting corporate earnings

While companies’ financial statements may seem straightforward, variables can be reflected in the earnings they report. It’s important to be able to understand the numbers that are most applicable to a stock’s valuation, and what might not be as pertinent.

“It is worth reading beyond the headline numbers,” says Haworth. “Unique, one-time events may affect earnings, either positively or negatively.” For example, if a company’s earnings declined due to a one-time major expense, that shouldn’t necessarily reflect poorly on its outlook. Similarly, if a company reports a strong boost to earnings, for example, because it sold off one of its business units, that may not reliably indicate future strength.

How earnings are reflected in the broader stock market

Analysts often use earnings estimates to determine whether the broader stock market is fairly valued. For example, annual operating earnings for the S&P 500, an index of approximately 500 large company U.S. stocks, totaled $196.95 per share in 2022. S&P 500 earnings for 2023’s first quarter were $52.54 per share, with second quarter numbers yet to be finalized.4 The anticipated change in that number going forward can provide investors with a broad sense of the market’s valuation.

As they do with individual stocks, analysts can also place a P/E valuation on the broader market. As of July 30, 2023, the P/E ratio of the S&P 500 based on earnings in the prior 12 months was 23.46, while the P/E ratio based on projected earnings for the next 12 months is 19.53.5 Analysts may set different valuations on the market based on varied sets of projections.

When fundamentals are overshadowed

If earnings are assumed to be the most fundamental measure of a stock’s, or market’s value, there are times when earnings are overshadowed. For example, in 2022, while corporate earnings were generally improving, stocks suffered a significant decline.

“In 2022, three primary factors shifted investor sentiment,” says Haworth. “High inflation, the Federal Reserve significantly raising interest rates and slower economic growth. Investors anticipated that all these factors would have a negative impact on the business environment, and ultimately, on corporate earnings.”

Markets experience such periods when non-market factors, some economic, some triggered by other events such as a geopolitical conflict or a health care crisis like the COVID-19 pandemic, overshadow current fundamentals related to earnings.

Preparing for the current environment

Haworth believes that earnings remain a primary focus for investors in 2023. “Now we’re waiting to see what impact the direction of the economy will have on business and consumer spending and how that affects corporate profit margins going forward.” Haworth says in 2023, the most favorable earnings reports appear to be centered among a narrow band of S&P 500 sectors. “Technology, communication services and consumer discretionary stocks seem to be performing best in the current economic environment,” according to Haworth. “Ultimately, we want to see broader participation in the market, both in terms of stock price performance and earnings results from individual companies.” There were signs of the market broadening out in July. Haworth notes if positive earnings results are spread out over more sectors, it could result in a more sustained stock market rally.

As you assess your investment options and how to best position your portfolio, it can be helpful to do so in the context of a financial plan. Talk with your U.S. Bank wealth professional to review whether changes to your investment strategy may be warranted to better reflect your goals, risk appetite and time horizon.

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  1. Source: U.S. Bureau of Economic Analysis.

  2. FactSet Research Systems, Inc., “Earnings Insight,” August 4, 2023.

  3. Source:

  4. Source: S&P Dow Jones Indices, “S&P 500 Earnings and Estimate Report,” August 2, 2023.

  5. Source: S&P Dow Jones Indices, S&P 500 Fact Sheet (USD), July 30, 2023.

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